Tax Topics for Freelancers, Contractors, and Consultants - S'witty Kiwi (2024)

If you are a freelancer, contractor, or consultant, you probably enjoy the freedom and flexibility of working on your own terms—making your choice of projects, clients, hours, and rates. You can also pursue your passion and creativity, and earn money doing what you love.

However, being your own boss also comes with some challenges and responsibilities, especially when it comes to taxes. Unlike regular employees, who have their taxes withheld and paid by their employers, you have to deal with taxes on your own. You have to keep track of your income and expenses, pay self-employment tax, make estimated tax payments, choose a business structure, and claim deductions and credits.

Taxes can be confusing and overwhelming for anyone, but especially for freelancers, who have to navigate a complex and ever-changing tax system. That’s why this article is here to provide you with useful tax information and tips to help you save time, money, and stress.

Here are some tax topics for your freelancing, contracts, and consultancy:

1. Choosing a Business Structure
2. Paying Self-Employment Tax
3. Making Estimated Tax Payments
4. Claiming Deductions and Credits

Interested? Keep reading!

1. Choosing a Business Structure

One of the first decisions you need to make as a freelancer is how to structure your business. This will affect how you pay taxes, how you protect yourself from liability, and how you manage your finances.

There are five main types of business structures that you can choose from sole proprietorship, partnership, limited liability company (LLC), S corporation, and C corporation. Each one has its pros and cons, depending on your situation and preferences. So, how can you choose the best business structure for your freelance business?

There is no one-size-fits-all answer to this question, as the best business structure for your freelance business depends on your specific situation and goals. However, here are some factors that you should consider when making your decision:

• Your income and expenses: How much money do you make and spend as a freelancer? How stable and predictable is your income? How do you manage your cash flow and budget?
• Your tax liability: How much taxes do you pay as a freelancer? How do you plan and save for your taxes? How do you file and report your taxes?
• Your liability risk: How likely are you to face legal issues or lawsuits as a freelancer? How do you protect yourself and your assets from liability? How do you handle contracts and agreements with your clients and vendors?
• Your growth potential: How do you plan to grow and expand your freelance business? How do you attract and retain clients and customers? How do you market and promote your business?
• Your personal preferences: How do you like to run and manage your freelance business? How much control and flexibility do you want over your business? How much complexity and hassle are you willing to deal with?

2. Paying Self-Employment Tax

As a freelancer, you are responsible for paying self-employment tax, which is a tax that covers your contributions to Social Security and Medicare. These are two federal programs that provide benefits for retirees, disabled people, and their dependents.

Self-employment tax differs from income tax, which depends on taxable income and bracket. Your net earnings—gross income minus company expenses—determine your self-employment tax. The flat 15.3% self-employment tax includes 12.4% for Social Security and 2.9% for Medicare.

You have to pay self-employment tax if your net earnings from self-employment are $400 or more in a year. You also have to pay self-employment tax if you earn $108.28 or more from church employee income. You have to file Schedule SE with your Form 1040 to report and pay your self-employment tax.

Self-employment tax can be a significant expense for freelancers, but there are some ways to reduce your self-employment tax liability, such as:

• Deducting half of your self-employment tax as an adjustment to income. This means that you can subtract 50% of your self-employment tax from your gross income, which lowers your taxable income and your regular income tax.
• Contributing to a retirement plan, such as a SEP IRA, a SIMPLE IRA, or a solo 401(k). These are tax-deferred accounts that allow you to save money for your retirement and reduce your taxable income. You can deduct your contributions from your gross income, which lowers your net earnings from self-employment and your self-employment tax.
• Claiming health insurance premiums as a deduction. If you are self-employed and pay for your own health insurance, you can deduct the cost of your premiums from your gross income, which lowers your net earnings from self-employment and your self-employment tax.

To estimate your self-employment tax for the year, you can use the following formula:

Self-employment tax=Net earnings from self-employment×0.153

Alternatively, you can use this online calculator to help you calculate your self-employment tax: Self-Employment Tax Calculator

3. Making Estimated Tax Payments

As a freelancer, you must pay your taxes throughout the year, instead of waiting until the end of the year. This is because you don’t have an employer who withholds taxes from your paycheck and sends them to the IRS on your behalf. You have to do this yourself, by making estimated tax payments.

You submit estimated tax payments to the IRS based on your predicted annual income and tax liability. If your tax return shows a $1,000 or more tax liability, you must make estimated payments. If your withholding and refundable credits are less than 90% of your current year’s tax or 100% of your prior year’s tax (110% if your adjusted gross income is over $150,000), you must estimate your taxes.

Making estimated tax payments is different from withholding taxes because you have to calculate and pay them yourself, instead of relying on your employer or a third party. Making estimated tax payments also helps you avoid penalties and interest for underpaying taxes throughout the year.

The IRS charges a penalty for underpayment of estimated tax if you don’t pay enough taxes during the year, either through withholding or estimated tax payments. The calculation of this penalty is based on the interest rate that the IRS charges on unpaid taxes, which varies every quarter.

To calculate and pay your estimated taxes, you can use the IRS Form 1040-ES, the annualized income method, or the safe harbor method.

4. Claiming Deductions and Credits

As a freelancer, you may be eligible for various deductions and credits that can lower your tax bill. Deductions and credits are two different ways of reducing your taxes, but they work differently.

Deductions are expenses that you can subtract from your gross income, which lowers your taxable income and your regular income tax, and credits are amounts that you can subtract from your tax liability, which lowers your actual tax payment.

For example, if you owe $5,000 in taxes and claim $1,000 in credits, your tax payment is $4,000, and you save $1,000 in taxes. To claim deductions and credits as a freelancer, you have to follow some general rules and requirements, such as:

• Keeping records of your income and expenses for at least three years, in case the IRS audits you or asks for proof of your claims.
• Tracking your expenses throughout the year, using a spreadsheet, an app, or software, according to the IRS rules which require that you separate your personal and business expenses.
• Substantiating your claims with required evidence and documentation, such as contracts, invoices, receipts, and statements.

There are many deductions and credits that you can claim as a freelancer, depending on your income, expenses, and circ*mstances. Some of the most common and beneficial ones are:

• Home office deduction. If you use a part of your home exclusively and regularly for your business, you can deduct a portion of your home expenses, such as rent, mortgage, utilities, insurance, and repairs.
• Travel deduction. If you travel for your business, you can deduct your travel expenses, such as airfare, lodging, meals, car rental, and parking.
• Vehicle deduction. If you use your car for your business, you can deduct your vehicle expenses, such as gas, maintenance, repairs, insurance, and registration.
• Equipment and supplies deduction. If you buy or use equipment and supplies for your business, you can deduct their cost, such as computers, software, printers, phones, furniture, and stationery.
• Education deduction. If you take courses or attend seminars that improve your skills or knowledge in your field, you can deduct your education expenses, such as tuition, fees, books, and materials.
• Health care deduction. If you are self-employed and pay for your own health insurance, you can deduct the cost of your premiums from your gross income, which lowers your net earnings from self-employment and your self-employment tax.

Recap

Are you a freelancer, contractor or a consultant? Pay attention to tax subjects such as selecting an appropriate business structure, paying self-employment tax, paying estimated taxes, and claiming credits and deductions.