It’s that time of year. You have W-2’s and 1099’s coming in the mail. It’s time to do your 2017 tax return. Whether you are a full-time freelancer or just make a little money on the side, I highly recommend consulting with a competent CPA for tax planning. This article contains basic information but you would need to consult a CPA for how it relates to your unique situation.
The difference between being a 1099 or W-2 employee is how the taxes are paid. When you are a W-2 employee, your employer deducts your taxes from your paycheck and sends it to the Internal Revenue Service (IRS) and (Your) State Department of Revenue. This money sits at the tax office all year until you file your tax return the following year. When you file your tax return, you are either get a refund or have to pay additional money. If you are getting a refund, that means you overpaid and they are sending you your money back. If you have to pay additional money, that means that not enough tax was deducted from your paycheck. Most people think it’s great when they get a big tax refund, but in reality those people gave the government an interest free loan. For purposes of financial planning, you are better off keeping more money in your paycheck throughout the year than getting a big refund the following year.
Taxes that may be deducted from your paycheck are as follows:
- Federal Income Tax
- State Income Tax (unless you live in a state that does not have a state income tax such as Florida)
- FICA (Federal Insurance Contributions Act)
Let’s briefly talk about FICA tax. FICA tax consists of a tax for social security and medicare. The concept is that you will pay those taxes throughout your life, and when you retire you will get money back as Social Security and Medicare. If you are a W-2 employee, FICA tax is 7.65% of your gross income. This consists of 6.2% for Social Security and 1.45% for Medicare. What most people may know is that their employee also “matches” that amount and also pays 7.65% to the IRS. When you are self-employed, their is no employer to pay the additional 7.65%. Because their is no one to match the 7.65%, self-employed individuals must pay the employee and employer amount of FICA tax, which is 7.65% X 2 = 15.3%. In the tax world, this is called Self-Employment Tax.
As a freelancer, you will need to pay taxes based on your profits. You can deduct expenses directly related to your business. It’s best to consult with your CPA to determine what expenses are deductible. Expenses can be things like internet access, office supplies, phone, automobile, licenses, advertising, and even meals. Just keep in mind that meals are only 50% deductible. I recommend coming up with a way to keep track of your expenses so that you don’t forget anything. Keeping a separate bank account for freelance income and expenses is ideal. If you can’t do that, I recommend having a spreadsheet or notebook where you can track them. Another idea is to just keep a folder with all of your receipts. I know CPA’s love getting a folder full of random receipts! I’m definitely kidding!
In addition to tracking your expenses, you will need to track your income. You will probably get a 1099 from each company that you worked for if they paid you $600 or more. You still are responsible for reporting income even if you didn’t get a 1099. You probably know that though.
To calculate your profit, simply take your income minus expenses.
If you earn a lot of money as a freelancer, you are probably paying estimated taxes each quarter to the IRS and your state department of revenue. The due dates for paying estimated taxes are as follows:
- Quarter 1: January 1 – March 31 – pay by April 15
- Quarter 2: April 1 – May 31 – pay by June 15
- Quarter 3: June 1 – August 31 – pay by September 15
- Quarter 4: September 1 – December 31 – pay by January 15 of the following year
It’s best to consult with your CPA, who can help you determined how much to send to the IRS and your state department of revenue each quarter. Allow an extra day (or more) for processing times. If you also have a full-time W-2 job or are married, you will need to factor in tax implications of all incomes added together.
If you don’t like dealing with estimated taxes, it’s possible to incorporate your business and pay yourself a salary from the business. This way the taxes can be deducted from each paycheck and paid through the corporation. Some people choose to set up a corporation so that they can receive a steady paycheck instead of dealing with the ups and downs of freelance income. I recommend consulting an attorney and a CPA if you choose this route.