Navigating the world of freelance tax can be intimidating and overwhelming. If you’re just starting out, you may be surprised to learn that the IRS requires anyone who earns money while self-employed to separate their income and file taxes as a business owner.
The good news? There are additional deductions and credits that you may qualify for as a freelancer. The bad news? There are also additional taxes you’ll be required to pay. If that sounds confusing, this guide will sort it all out for you. Here are the top 10 freelance tax terms you should know to properly navigate tax season.
When you’re considered an independent contractor rather than an employee, you won’t receive a Form W-2 from your clients. Instead, if a company or individual paid you more than $600, they’ll likely issue you a 1099-MISC. Just remember that all income earned as a freelancer needs to be reported on your tax return, regardless of whether or not you received a 1099-MISC from a particular client.
2. Credits vs. Deductions
Oftentimes, indys confuse tax credits with deductions. Let’s clarify: A credit directly reduces the amount of tax you owe, serving to lower your taxable income dollar-for-dollar. For example, a $1,000 tax credit reduces your taxes by $1,000.
On the other hand, a deduction reduces the amount of your income that’s subject to tax, and it’s based on your income tax bracket. For example, if you fall into the 25 percent income tax bracket, a $1,000 tax deduction will save you $250.
3. Employer Identification Number (EIN)
The term EIN stands for Employer Identification Number, and it’s considered the business version of a Social Security Number (SSN). Not all freelancers need an EIN, since it’s perfectly fine to operate using your SSN. However, if you incorporate your business, become a partnership or operate as a single-member LLC, you’ll likely file for one of these.
4. Quarterly Estimated Tax Payments (QETs)
The IRS requires all income to be taxed the moment it’s earned. That’s why employers withhold taxes from employee paychecks (and pay payroll taxes every month on their behalf). Likewise, as an independent contractor, you’re required to pay estimated tax payments every quarter.
Your “quarterlies” have to be filed and paid four times a year using Form 1040-ES before the specified due date. The total tax paid throughout the year is credited to the tax owed on your income tax return. But if you fail to pay your QETs, you might get hit with a late fee and tax penalty during filing season.
5. Filing Status
For tax purposes, your filing status determines your tax rate and the size of your standard deduction. You can choose from “Single,” “Married Filing Jointly,” “Married Filing Separately,” “Head of Household” or “Qualifying Widow/Widower.”
6. Gross Income (and AGI)
Gross income, or gross receipts, is the entire amount you earn from the various projects and services you perform as a freelancer — before you subtract taxes, payment fees and business expenses. When calculating QETs, you’ll take the gross income you earned to find the amount of tax you owe for that quarter.
Adjusted gross income (or AGI) is income added up from all sources minus certain adjustments or above-the-line deductions. This can include adjustments like a contribution to your Health Savings Account or a deduction for 50 percent of self-employment tax paid.
7. Home Office Expenses
Since most freelancers work from home, the home office deduction may be applied to your tax return. When your home’s your principal place of business, you can write off home office expenses like utilities, rent, homeowner’s insurance, property taxes, repairs and maintenance. But be aware: You can only qualify for the home office deduction if the space in question is exclusively and regularly used for business purposes.
8. Income Tax Bracket
An income tax bracket is made up of a certain percentage of tax that’s owed on a specific range of income for taxpayers. As your income rises and falls — or you get married, divorced or have kids — your income tax bracket may change.
9. Schedule C
If you operate as a sole proprietor or single-member LLC, you must file a Schedule C along with your personal tax return. This form is used to record profit or loss from business income in order to calculate the net income from freelance activities. Here’s a breakdown of the different parts of Schedule C:
- Part I is used to input information related to your income.
- Part II includes qualified business expenses.
- Part III is used for “Cost of Goods Sold.”
- Part IV is where you can record information about using a vehicle for business.
- Part V is for all other expenses that can’t be categorized elsewhere.
10. Self-Employment Tax (SE Tax)
In addition to your income tax bracket, self-employed freelancers also have to pay self-employment tax. SE tax counts for 15.3 percent if your income, and it consists of the Social Security and Medicare taxes that an employer would typically pay on your behalf. However, as an independent contractor, you’re required to pay these taxes yourself.
With this basic list of freelance tax terms, you’re now an expert in everything tax-related that a self-employed contractor should know. Armed with this information, you’ll be able to reduce your taxable income and maximize your tax savings when tax season rolls around.