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The Ultimate Guide on Accounting, Bookkeeping, and Tax for Freelancers

The Ultimate Guide on Accounting, Bookkeeping, and Tax for Freelancers

Once, freelancing was only limited to certain industries like designing, writing, films, and editing. Today, the demand for people who work independently has increased by as much as 47%.

Did you know that over 57 million freelancers in the U.S. work alone? While working for yourself is often rewarding, tax time isn’t as refreshing. In this post, we will provide a complete ultimate guide for freelancers to manage your finances and tax without breaking a sweat!

So, let’s get started.

Setting Up Your Business For Success

Do I Need to Register My Freelance Business?

You don’t have to make any official recording of your freelance business. The IRS will treat you as an independent contractor and impose a self-employment tax on your income. 

You can pay the taxes through your individual filings without any issues. 

IRS also allows freelancers to register as LLCs and S corps, which may bring some tax benefits. In such cases, you will have to approach the government for registering your business. 

Most freelancers choose to work as a sole proprietor for simplicity. Here’s a look at the nuances of different business models-

We have namely five business models that differ in ways of taxation, number of owners, and your nature of liability. We will now discuss a few of the models that are suitable for most freelancers in detail.

A Look at Sole Proprietorship

You are automatically treated as a sole proprietor by the IRS in the case of freelance. So, you don’t have to worry about registering or any legal requirements.

As for taxation, your business income will attract self-employment tax. You can, however, pay your taxes through your individual filing.

The sole proprietorship model is most risky as you and your business are considered the same. So, you are liable for all business debts and lawsuits. 

Go for this business model if you-

  • Want the least cost and hassles
  • Earn through other ways
  • Are a casual freelancer

LLC or Limited Liability Company

LLC is the middle path for freelancers and needs registration and documentation. However, the complexity is much less than registering a corporation that has many regulations.

LLCs limit your liability and protects your assets and belongings against business debts. Any legal actions are also filed against your company and not you. However, you will still be liable for claims for your negligence, like leaking or exposing client data without permission.

LLCs allow you to treat your taxes under sole proprietorship. You also have the choice of going for S Corp or C Corp taxation, which makes sense if you are earning a high income.

Paying taxes as a sole proprietor

  • You can file your taxes through your personal filings
  • IRS will charge income tax and self-employment tax

Paying taxes as a C Corp

  • Corporate tax of 21% through corporate filing will apply
  • Salary from your business will attract income tax through personal filings

Paying taxes as an S Corp

  • You can report your income through personal filings
  • IRS will charge self-employment tax on the salary you take from your business
  • Extra income after paying taxes comes back through dividends

Go for limited liability business model if-

  • You work freelance full time
  • Earn only from freelance
  • Own multiple businesses
  • Possess high valuation

A Look at Possible Tax Savings as an S Corp

Let’s say you take a salary of 30% from your net income doing freelance as an LLC. You have to pay a tax of 15.3% for self-employment for the first net income of $137,000. Incomes over this amount will attract an additional 2.9%. From that, you can subtract 50% employment taxes.

Here’s how much you may be able to save in taxes-

Note: The salary you take from your freelance business should be reasonable, aligning with the rest of the industry. Quoting low salaries to save taxes can land you in trouble with the IRS. 

Will I be able to save taxes by filing through S Corp?

Filing as an S corp is profitable only if it results in tax savings. 

  • Estimate your yearly net income and salary (matching industry standards)
  • Deduct your salary from net income
  • File taxes under S corp only if the result is positive

How to Register Freelance Business as LLC

You can use the Form 2553 to file taxes to the IRS under S corp. 

1. Research Well. LLC requires you to make your business official in all states where you run operations. You should approach-

  • Your local office of Secretary of State 
  • Business Bureau
  • Business agencies

2. Come Up with a Name. Choose a name for your business, and then you can register your company, trademark, and domain name. Your business name will only need registration for a typical freelancer.

3. Approach Registered Agents. Business registration agencies can reduce your effort and help you get your registration done. They can handle all documentation and legal requirements. 

4. Register with Government. Online is the best way to get your business recorded. Check what you need to submit to the IRS here

You may also send documents through mail or in-person.

5. Get Your Federal Tax ID. Your Employer Identification Number (EIN) is essential to submit tax returns and hire employees. EIN is also required to open a bank account for your business. 

6. Do You Need Any Permits? Some freelancers may have to get permits and licenses for their business. Check with your state and website of Secretary of State for more details.

How to Pay Taxes as an S Corp under LLC

You can use the Form 2553 to file taxes to the IRS under S corp. 

How to Manage Your Finances

Freelancers should track all their income and business expenses to save more tax. Your business expenses are the most crucial and include work-at-home costs. 

Depending on the complexity of transactions, a simple income and expense account can do the job. 

Why You Need to Record Finances

Account or bookkeeping is the easiest way to for sorting and recording your business transactions. It helps you track income from each client and even ensures timely payments. As a result, accounting is the key to improve your profitability. 

Prepare Proper Quotes

Sending detailed quotes and estimates allow your clients to get a clear idea of your pricing. Additionally, the practice can help you-

  • Get a good rate
  • Keep an estimate of the timeline
  • Prepare invoices quickly 
  • Get paid quickly

Aim for Timely Payments

Clients can have several reasons for not paying on time. However, it’s your job to send invoices on time and follow up with payment reminders. 

You can use tools like Google Calendar to keep track of your payment dates. 

How to Track Income

Open a business bank account to stay updated on every payment from your clients. In fact, you will need a business account to register as a C corp or LLC. Business accounts also come with several perks, like tax management and billing. 

Operating as a sole proprietor doesn’t need any business account. You are allowed to use your personal bank account. However, it’s a good practice to handle your expenses using a dedicated personal account or cards. 

Platforms like Freelancer and Upwork also provide earnings summary in your account. Check out the top credit cards and business accounts for freelancers right now.

Accounting for business expenses

A credit card or business checking account can help you keep a record of what you spend for your business. You can even use a spreadsheet or digital accounting tool to organize the transactions. 

Platforms like Freelancer and Upwork also provide earnings summary in your account. Check out the top credit cards and business accounts for freelancers right now.

Accounting for cash transactions

Cash transactions come with a degree of challenge. You should make every effort to record your cash income and expenses. Otherwise, the IRS can charge penalties for being unable to inform your receipts.

  • Keep records of all cash expenses and receipts
  • Always ask for receipts from clients
  • Create personal receipts if clients fail to send receipts
  • Get your receipts signed by your client

Stay safe on your part to avoid any coercive actions from the IRS. 

Filing Your Taxes

Taxes Paid by Freelancers

If you earn over $400 yearly from your freelancing, you will have to pay self-employment tax and income tax. Income from freelancing platforms will also be subjected to the same taxes.

Self-employment tax: The tax rate is 15.3%. It’s calculated on the initial 92.35% of freelancing net income.

Federal Insurance Contributions Act (FICA): You will also have to pay your taxes for social security at 12.4% on the initial $137,700 of your income (2020).

Medicare is applicable at 2.9% if your income crosses-

  • $200,000 (individual payers) 
  • $250,000 (couple filings)

Income tax: General income tax will be applicable on your freelance income based on how much you earn. Here is a look at what you may need to pay-

Sales tax

Some states may require you to charge a sales tax from your clients. You should consult your local authorities to know if you should collect sales tax from your clients.

Not collecting taxes from your clients when you’re supposed to will put the responsibility of paying the taxes on your shoulders. 

Use the following resources:

Estimated Tax Filings for Freelancers

Freelancers might have to pay taxes each quarter by estimating income. This is applicable if you think your taxes will cross $500 (corporations) or $1,000 during filing return. Or, if you expect the credits refunded from taxes to make up 90% or less of current year’s tax bill or the full value of the previous year’s bill.

The applicable limit is 110% for freelancers who earned an adjusted gross income of over $75,000 (single payers) or $150,000 (joint payers) in the previous year.

You will need to pay within the deadlines for each quarter-

  • 1st quarter – April 15
  • 2nd quarter – June 15
  • 3rd quarter – September 15
  • 4th quarter – January 15

How to work out your taxes per quarter

  • Estimate the amount you may earn and spend for your business in the year
  • Think of what you earned last year
  • Accommodate for current changes and consider changes in net income
  • Deduct your expenses from your income (both are estimates)
  • Split into 4 parts and pay each quarter

How do you pay?

  1. You can pay your taxes online via IRS platform
  2. Mail your filled-in form 1040-ES by attaching your check
  3. Using the Electronic Federal Tax Payment System for corporations

How to play safe with your taxes

To avoid underpaying taxes, turn in what you submitted to the IRS in the previous year. If you earn over $150,000 annually, look to submit 110% of the previous year’s amount. Additionally, never miss due dates. 

Overview of Tax Forms and Documents 

Your clients will send you tax documents at the end of a tax year. You can also get the same from the freelance platforms where you sell your services. Generally, you will have to deal with Form 1099 and its subtypes, which are more than 20. 

However, most freelancers will be okay with form 1099-MISC and 1099-K – these record your earnings that are related to your freelance business.

Form 1099-MISC

Clients who made a payment of over $600 will need to send you a form 1099-MISC. This form presents a record of all your income from the specific client. Naturally, a freelancer gets multiple 1099-MISCs at the end of a tax year. 

The 1099-MISC resembles the form W-2 issued to contractual employees, and act as a record of your income.

How a Form 1099-MISC Looks

  • Your total yearly earnings from a specific client will be placed in field 7.

Form 1099-K

Freelance platforms and third-party networks issue Form 1099-K when they make you payments. As a result, it’s not a record of earnings, but of payments made to you. The amount will include any charges or fees you paid from your own money. You should use the breakup of the amounts to separate your business income. 

Platforms like Freelancer and Upwork send you Form 1099-K only when-

  • You made more than $20,000 in the form of revenues, and
  • You have made over 200 transactions

Both revenues and the number of transactions are applied to the previous tax year. 

How a Form 1099-K Looks

  • Field 1a presents the total income from your freelance business 
  • Field 5 presents the number of projects you received payments for
  • Fields 5a to 5l present the monthly payments by the freelance platform

The numbers on the tax forms need to match your records. Act immediately if you find any discrepancy and take efforts to discover the issue. If necessary, get in touch with your clients or freelance websites to resolve the problem.

What if I don’t earn enough to receive a Form 1099?

Whether you make $20,000 or not, the IRS mandates you to report your income accurately. You can always use your records and data for the purpose, and even use the information on your freelance platform accounts. 

How to Reduce Your Tax Amount Legally

IRS allows you to deduct business expenses from the total amount of tax you owe. These deductions are available to all businesses, whether you are a freelancer or a corporate. The tax deductions bring down the total tax you have to pay and account for all business costs.

All freelancers need to have an accurate record of all your expenses for business purposes. We already told you how you could track your expenses above. Now, we will explore the typical expenses related to a freelance business.

Home Office Deduction

Most freelancers work from their home or a dedicated workspace. IRS allows you to deduct home office expenses from your total tax payable. A range of expenses can be included in home office deduction and will depend on several factors. 

For example, if you own your workspace, you will be able to deduct the cost of property depreciation and home loan interest. However, these won’t be available to freelancers who rent their workspace. They will be, though, able to deduct rent for the office space. 

Whether you deduct rent or depreciation, the amount must be limited to the space you use for your office. So, if the workspace makes up 20% of your property, you can deduct 20% of the total depreciation of your home. 

It’s important to have an accurate measurement of your workspace for backing up your deductions. Additionally, the IRS may also conduct audits to substantiate your claimed deductions. 

The best way to defend yourself is to keep a ready plan or blueprint of the home office. Be sure to use the actual numbers to help IRS calculate your square footage for taxation. 

Along with workspace expenses, other costs related to your workspace are also deductible. These include-

These expenses should once again be limited to the area of your workspace, as we discussed above. 

How to calculate home office deduction:

IRS gives you two ways to determine your home office expenses-

Simplified method: You can use a simple amount set by the IRS to claim your home office expenses. As of now, you can claim $5 for each square foot of your workspace. However, there are two conditions-

You can’t deduct any itemized deductions associated with your property

Your workspace cannot be over 300 sq. ft.

The maximum expenses you can claim under this method will be $1,500 ($5 x 300). As a result, it may not be the best if you think your actual expenses or workspace area is more. You can then use the following method.

Standard method: Here, you have to keep track of the actual expenses to claim them as deductions. You can include all the expenses we discussed above to bring down your total tax. Proper bookkeeping will help you create an accurate record of your workspace expenses. 

Other Expenses

Overheads

All businesses have overheads. In the case of freelance, your electricity, internet, and telephone bills form a part of your on-going expenses. Naturally, the IRS will allow you to deduct any such expenses from the total tax payable. 

However, the costs must be limited to the business use of resources. If you get a single electricity bill, then you can deduct the percentage you use for freelancing. For instance, you may deduct 15 – 20% of the total electricity bill. Consequently, if your workspace has a separate bill, you can subtract the full amount of your bill.

The same applies to expenses like mobile and phone bills, internet charges, and so on. 

Advertising expenses

You can claim all costs related to marketing or advertising from your tax amount. Today, many freelancers advertise their services on social media platforms and search engines. The cost of any such ads, whether on Facebook or Bing, are considered business expenses. 

Traditional advertisements like ads in magazines and billboard costs are also welcome. You may also claim the costs of advertising for charity with your brand or company name.

Automobile expenses

Whether you ride a car or a motorbike, the miles you drive for business can be deducted as business expenses. For instance, if you drive to your client’s office to give a demo of the app you made, you can claim the miles on your tax returns. Like, other expenses, you have two methods to calculate your vehicle-related expenses-

Standard mileage method: IRS allows you to charge 57.5 cents per mile you drive for business in 2020. You just have to keep a date-wise record of business miles and multiply them with 57.5 cents. The result you get can be reduced from your total tax. 

Actual cost method: Here, you can include all the costs you incur on your vehicle for business purposes. All operating expenses, like fuel costs, insurance, taxes, and maintenance, are allowed. 

Find out your total operating cost and then deduct the percentage used for business. Let’s say your operating expenses for your car adds up to $2,500. Now, out of the total vehicle use, 25% is for business, and 75% is for personal purposes. 

So, you will be able to deduct $2,500 x 25% = $625.

Travel expenses

Expenses you make while traveling for business are allowed as tax deductibles. Obviously, your travel must include planned business activities like acquiring new leads, attending a skill-development workshop, or giving a presentation to a client. 

Additionally, there are certain specific conditions for any travel to be considered as a business one-

Duration: Your travel must be an overnight matter or longer than a normal working day. 

Distance: You can’t be located in the vicinity of your tax home. Generally, you will need to travel to other cities or states, away from your business location.

Planned: Your business activities must be planned ahead and can’t be impromptu. 

Business activities: You should perform actual business activities, as we mentioned above.

Track All Your Expenses

You will be able to claim all expenses if your trip is solely for business purposes. These include-

  • Cost of travel (train or airfares)
  • Accommodation expenses (hotels, hostels)
  • Intra-city or state travel (bus fares, cab rides, subways)
  • 50% of your food expenses

You should save all the receipts and bills you get during your business travel. They are 100% deductible from your tax returns. However, your expenses should not include a stay at 7-star resorts or luxurious arrangements. On the contrary, you also don’t need to sleep in a rat hole!

Any reasonable expense is allowed. Use your prudence and go for options that make sense. For instance, if your business deal is worth $3,000, then your travel expenses shouldn’t add up to $2,900!

In case your trip involves both pleasure and business, you can claim expenses limited to your business. No personal or entertainment expenses are allowed.

Food and pleasure

Meals or drinks bought for hosting a client can be deducted as business expenses from your tax. However, what you eat sitting in your home office doing your work is not a business expense.

You can claim either-

  • 50% of the actual cost of the food provided you save the bills
  • 50% of the general meal allowance 

For the second method, you don’t need to save the bills. You just need to record the day/time, location, and business purpose. Here is a detailed resource to learn more about the business expenses allowed by the IRS. 

20% Tax Break for Freelancers

As a freelancer, you can enjoy a 20% pass-through deduction on the total profits to reduce your taxes further. The IRS launched the tax break in 2018 and has been a great help for small and medium business owners. 

This tax break is only available when you report your freelance income through your personal filings.

The threshold for 2020:

The maximum income limit is-

  • Single taxpayers – $163,300
  • Joint taxpayers – $326,600

How to calculate:

  • Subtract 50% self-employment tax from your total profit
  • Deduct 20% of the amount from your payable tax

Example:

Let’s say your profits from your freelance business for the current F.Y. is $100,000. 

So, self-employment tax is ($100,000 x 92.35%) x 15.3% = $14,129

Now, 50% of the tax is $14,129 x 50% = $7,064

Subtracting the tax you get $100,000 – $7,064 = $92,936.

So, your pass-through deduction will be $92,936 x 20% =$18,587. 

How to Submit Your Taxe Returns

Do It Yourself (DIY)

Get online

You have several ways to file your taxes with the IRS. The simplest of them is to go online and file your taxes on the IRS website. You will need to register and use your cards or bank transfer to pay your taxes. 

Send by mail

You can also mail your tax return to your local IRS office. You can request tax forms over the internet and attach your check to pay your taxes. 

New freelancers can use our resources to fill out tax forms with step-by-step instructions. You can also use a digital tax solution to streamline workflow and improve the accuracy of your filings. Using software can also save time and help you get more refunds.

Seek Guidance from a CPA

Licensed accountants can help you file your taxes without breaking a sweat! Moreover, a CPA can assist you in identifying potential areas of tax savings. They can provide professional guidance and help you comply with all tax laws and regulations. 

Additionally, you can always stay prepared for any IRS audits and ensure the full credibility of your financial records. 

You can get an accountant to do your taxes for around $150 to $300. They are a bit costly but can help you save taxes that cover the fees comfortably. So don’t be shy to ask for help when you need it!

Preparing your tax as a freelancer is not a difficult task. But if your business is complex or you have too many clients, you may need proper accounting and bookkeeping. Additionally, an accountant can always facilitate your filings and maximize deductions.   

About Zoey Wen

Content contributor and website admin @ Exper.

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