Disclaimer: The calculations provided should not be considered financial, legal or tax advice.
The Internal Revenue Service requires that all freelance income above $400 a year be reported, and that profit from income made as a freelance (or independent contractor) be subject to the appropriate tax rate. This means that you should count earned income in the form of cash, check, PayPal payments, or other methods of compensation and include it on your schedule C form. It doesn’t matter if you received a notification or statement of earnings from a company documenting your pay; not all earnings will trigger a tax form, so you need to be tracking all earnings on your own.
What you pay taxes on, however, will depend on the formula of business earnings minus business expenses (which gets you to your magical “profit” number.) You will only be taxed on that profit. It’s also wise to know what your tax liability is each year, and see if you may be required to make estimated quarterly tax payments. Generally, if you don’t think you’ll owe more than $1,000 in taxes – after subtracting federal income taxes – you probably won’t need to make quarterly payments.
This is the tax amount paid on earnings from a sole proprietorship or partnership business that goes to Medicare and Social Security; it is also referred to as SECA. Since you are your own employer, you do not have a boss to take out (or withhold) this money from your check, so you must pay it yourself at tax time. You also pay at a higher rate than a traditionally-employed person, because you have no employer to pay part of the taxes for you.
The Self-Employment tax is calculated on 92.35% of your total income. This rate is derived from the fact that self-employed taxpayers can deduct the employer's portion of the tax, which is 7.65%.
The tax rate is currently 15.3% of your income, with 12.4% going to Social Security and 2.9% going to Medicare. The Social Security portion has a limit on how much of your income is taxed (currently $127,200 or less), whereas the Medicare portion does not. You must pay this tax if you’ve made money from your freelance business of $400 or more.
This portion of the tax freelancers pay goes to fund the federal government’s Medicare program. It is used to provide subsidized health care and programs to retired Americans and to disabled individuals. Money from the Medicare program also subsidizes hospital insurance benefits. So, when you pay your self-employment tax, less than 3% of that money is going to this program.
Similar to the Medicare Tax, this is a portion of your self-employed tax that supports another government program – specifically, the Social Security program. Social Security is known for the cash benefits it provides to seniors, but it also plays a role in supporting the disabled and surviving spouses and children. One important thing to note is that Social Security Retirement Benefits are based on your highest 35 years of earnings in a lifetime. Your freelance income is counted into this formula; the more you make and report as a freelancer, the closer you’ll be to maxing out Social Security retirement benefits later in life!
Yes. It’s very important to understand that you will always pay Self-employment taxes (those that contribute to the Social Security and Medicare programs) as long as you make more than $400 in a given tax year. You may also pay income taxes, which are figured out differently for different earning brackets. Since you will pay both income and self-employment taxes on profit made from your freelance business, it is beneficial to try to claim every legitimate business-related expense you can.
One other important rule of thumb is this: While those working for an employer can avoid even filing taxes if they make below the filing threshold, this is because they have money withheld from their paycheck to cover the Social Security and Medicare taxes (referred to as “FICA” when paid through your employer.) Since freelancers really have no easy way to withhold these taxes, they must pay them at the end of the year on a tax return, even if they made very little. Remember, anything earned over $400 will require you to file and pay the self-employment taxes -- regardless of whether you’ll owe actual income tax.
If you’ve earned over $600 from any one client or company in a given year, they are required by the IRS to send you a 1099-misc. When you signed the initial contract with a client, they likely gave you a W9 to fill out, granting them permission to use your social security or EIN number for tax purposes. This information is used to generate that 1099 at the end of the year, and you’ll need to verify the info to ensure it is correct.
While you won’t mail in your copy of the 1099 to the IRS, you will report that number as part of your total earnings on your taxes, so be sure that you don’t miss any amounts! The client will send a copy of the 1099 to the IRS, so you need to make sure your numbers add up. 1099 income needs to be included in your total earnings, along with cash, checks, bartering or other valuable compensation.
What if your client pays you with a credit card or through PayPal? These tools are considered a third-party payment processor, so the company paying you would not need to issue a 1099-misc in these situations. Instead, the payment processor or credit card company would send you a 1099-K. It looks the same as a 1099-misc, but is only issued if you meet certain thresholds.
Currently, your transactions need to total $600 or more for a credit card processor to issue a 1099-K. A third-party processor such as PayPal or Amazon requires you to make over $20,000 in payments from the one processor and have over 200 transactions. If you don’t hit the threshold for these, you’ll still need to report that income, you just won’t get a 1099-K to document it.
They sure do! Expenses – legitimate ones – can be the best way to decrease your profits and subject less money to taxes. If you can count up all of your reasonable business expenses, they will be deducted form your total sales or earnings and that final remaining amount (also called “net profit”) is what the IRS will use to determine your taxes.
Remember that your deductions need to be reasonable and related to your business, but the possibilities are huge. Common things that freelancers deduct include:
- Subscription services
- Office space
- Cell phone
- Travel costs
- Business card
- Web hosting
- Individual health insurance plans
If you use it solely for your business, and not for personal use, it’s a good bet you can use it to lower your total income earned and pay fewer taxes. In the event that you don’t earn anything after expenses, you won’t owe either income or self-employment tax. Just be sure that you’re aware that consistently earning large amounts of money that has been reported on a 1099, but showing no profit, can cause a red flag for the IRS. You want to be honest in your reporting to avoid costly fines or penalties down the road.
The self-employment tax is specific to US freelancers. If you’re not a US citizen or live outside the US, you should check with a local accountant.