Freelancers typically will file taxes as a Sole Proprietor which means they will file a Schedule C form that gets integrated with their personal tax return. Once they reach a point where they are making thousands in net profit, they may want to look into filing as an S-Corp. S-Corp status is more complex and may offer some tax benefits–but at that point, I’d consider them a full fledged business rather than a freelancer.
As far as actually filing taxes, a freelancer can easily use a DIY software like HR Block or Turbo Tax, or they can hire a tax professional. When hiring a tax professional, keep in mind that the IRS does not require any training whatsoever to become a tax preparer. You read that right. This means anyone can be a tax preparer. It’s up to you as the tax payer to do your due diligence in finding out a trustworthy and qualified preparer. Usually if someone is an EA or a CPA, you can count on them to know what they’re doing. Hiring a CPA or EA is obviously going to be more expensive but you can pretty much guarantee that you’ll be maxing out your deductions and getting an accurate tax return. Using a DIY software is completely doable, and will be more affordable, but make sure that you’ve got accurate bookkeeping records so that you can maximize your tax deductions (aka expenses, basically..)
The general consensus to set aside for taxes is 30%, broken down in this way:
As far as 1099s, a freelancer may or may not receive a 1099 depending on how much money they receive from any one given source. However, regardless of whether a 1099 is received or not, all income must be reported–even income received in cash.
Freelancers don’t have to worry about paying quarterly taxes until their tax owed reaches $1,000. A good judge of this is to take a look at the prior year’s tax return. Did you pay $1K in taxes or more? If so, then you should think about setting up quarterly tax payments. The best way to do that is to speak with a CPA or EA.
Freelancers, just like anyone, would get a tax refund only if they overpaid taxes throughout the year. When you have a job and you get paychecks from your employer, you have taxes that are withheld–those are essentially prepayments of your taxes to the IRS. If you over pay, you get the overpayments back in the form of a refund.
For a freelancer, however, you aren’t paying taxes throughout the year in this way (the only way to pre-pay would be to submit quarterly estimated taxes), so it’s very possible that a freelancer would not get a refund, and instead might end up owing taxes. This of course depends on other income received (for example, income from a spouse), and many other factors since the freelancer’s business income gets integrated with their personal tax return.
The only expenses that cannot be deducted are entertainment expenses and 50% of meals (update–for 2021 & 2022, meals are 100% tax deductible YAY! But remember, they do have to have a business purpose). Virtually all other business expenses are tax deductible. The catch here is that the expenses must be ordinary and necessary. So, what does that mean? Think about a hair stylist and a real estate agent. The hairstylist might have expenses like shampoo–totally ordinary and necessary. However, if a real estate agent was trying to deduct shampoo, that would not go over well. It has a lot to do with the industry, but if it’s a normal expense in your industry, it’s usually tax deductible.
Another deduction that causes issues in every industry is cell phones. If you want to play it safe (which I always suggest), do not deduct your personal cell phone or simply deduct a percentage of your specific phone line (not a percentage of the entire family’s plan). Personal expenses are never tax deductible and personal cell phones create a very grey area. If you want to deduct your cell phone in full, get a second phone line specifically for business.
The biggest thing to understand for freelancers is that even though they are “freelancing” which tends to have the connotation that it’s just a side gig, to the IRS, it’s still a business so keeping accurate and detailed records is key. Not only will that help freelancers understand how well their business is performing, it will make filing taxes a breeze.
All business owners–whether they are freelancers or big-time CEOs need to have a basic understanding of accounting and taxes so they can make their money work for them.