When you took the leap into self-employment, two of your main concerns were probably health insurance and taxes. Oh, the dreaded taxes. Instead of paying them once a year, you get the pleasure of paying four times a year.
Quitting my job to pursue self-employment felt like a natural fit — I had already started making as much as my non-profit day job. During that first year of self-employment, I doubled the income (hello, new tax bracket!) of my 9-to-5 and paid off the last of my $81,000 in student loans.
I felt great. I was making more money, I was finally debt-free and I was my own boss. But that feeling came to a screeching halt when tax time rolled around.
Getting Hit With a Huge Tax Bill
When I discussed my tax bill with my accountant after my first year of self-employment, I gasped: “I owe how much?” I was perplexed at how the amount could be so high.
I owed almost $10,000. But I had just paid off my student loans, and didn’t want to get back into debt with the U.S. government to pay off my tax bill. So I depleted my emergency fund to pay the bill and started back at square one. I’m not going to lie: It hurt — it really hurt. Just six months earlier I had depleted my emergency fund to pay off the last bit of my debt, and I had finally rebuilt it to have that much-needed cushion the freelance life requires. Suddenly, everything I worked for was gone. It felt like a major setback, but I learned some valuable lessons.
What Went Wrong?
When I got hit with this huge tax bill, I kept wondering, “What went wrong? How did this happen?”
As it turns out, my income had steadily increased — almost imperceptibly at first. In fact, my income grew so much that I was bumped into a new tax bracket. I failed to realize this at the time, and ended up saving less than I should have.
I started working with an accountant too late, after the damage was already done. I didn’t have anyone to guide me when I was trying to figure it out as I went — clearly, I don’t recommend taking this route. I also didn’t truly understand how local tax rates would affect me, and the overall self-employment tax was still a mystery. It was a recipe for disaster from the start.
How to Stay on Top of Your Taxes As a Freelancer
If this scenario sounds like a nightmare, there’s good news. There are a few things you can do to avoid it.
Step 1: Always save more than you think you should.
In the beginning, I read a few blog posts about how much you should save as a freelancer. Some said 20 percent, while others said 25 or 30 percent. I saved somewhere between 20 and 25 percent, but I failed to take into account the local state tax rates and the impact of entering a new tax bracket.
Now, I’m saving between 40 to 50 percent of my income and setting it aside for taxes. While that sounds like a lot, it ensures that I always have money left over for my quarterly tax payments. The good news: If you save too much, you can roll it over to another tax quarter or use it for something else.
Step 2: Work with a tax professional.
I wish the first thing I did as a small business owner was to hire an accountant. But I hired one too late, and suffered the consequences. Working with a tax professional who can guide you toward an idea of what you should be saving is essential as a freelancer. Even better, they can also make sure you’re maximizing your deductions, and they’ll let you know when you enter a new tax bracket.
Step 3: Complete regular check-ins.
In my first year of business, I was so excited that I was earning more money and keeping my clients happy that I didn’t properly check in with my finances. I knew I was making more, but didn’t know how much more.
Now, I do monthly check-ins of my income and expenses to gauge where I’m at. I ask myself the following types of questions: Do I have enough to cover bills, business expenses, health insurance, retirement planning and so on? And will I have enough left over to pay my quarterly taxes?
The Financial Bottom Line
Being a freelancer can be extremely rewarding. But when it comes to taxes, it can be super stressful. It’s important to stay on top of your finances and your unique tax situation to avoid any trouble down the line. Working with a tax professional or using an automated tax savings app that does all the work for you can help you manage your payments, allowing you to avoid hassle and headache when tax season rolls around.