Are you thinking about next year’s taxes? If you’re an independent contractor, you should be.
It’s never too early to get your tax documents organized and ready for filing, especially if paying estimated quarterly taxes is something you want to consider (hint: it is).
As more Americans seek autonomy from freelancing, often turning side hustles into second or third careers, it’s essential to consider the tax realities when transitioning from a W-2 employee to an independent contractor.
Adventures in Freelancing
Freelancers are responsible for paying self-employment tax. The self-employment tax rate is 15.3%, divided between Social Security (12.4%) and Medicare (2.9%).
Amidst the pandemic, more Americans than ever before quit their jobs, choosing instead to turn passions and side hustles into careers. Freelancing offers autonomy, flexibility, and more growth opportunities than the traditional 9 to 5 work model. As a result, 59 million Americans freelanced last year, representing 36% of the workforce.
Freelancers contributed $1.3 trillion to the U.S. economy. According to a report by Upwork, 68% of new freelancers say that career ownership is the primary motivator.
While freelancing offers new career opportunities for entrepreneurs and self-motivated individuals everywhere, it makes life a little trickier around tax season. Many experts recommend paying quarterly taxes and even starting to organize all your documents as soon as the new year begins.
Another item to consider is whether you should be issuing yourself payroll or not. If so, you would also want to file quarterly payroll tax returns to the IRS and your state. However, this is something a payroll service can do for you.
What Do The Experts Have To Say?
Play Louder talked with some finance experts to learn their best advice when it comes to preparing for tax season as an independent contractor.
“Treat bookkeeping and accounting as a weekly habit, not something you do at tax time,” encourages Marina Vaamonde, the owner and founder of HouseCashin, America’s biggest marketplace for selling off-market houses.
Marina has been managing her taxes for years as a small business owner. Budgeting time to organize your documents is essential. “I would schedule an hour every week on Friday morning to review my company’s books, check my invoices, verify receipts, and make sure my finances were in order,” she says. “This way, if something were wrong or missing, I would catch it right away rather than five or six months later when I’m super stressed about doing my taxes.”
She also recommends paying quarterly taxes. “This helps you maintain a more stable cash flow throughout the year,” says Marina.
Quarterly taxes are calculated by estimating the adjusted gross income, taxable income, taxes, deductions, and credits.
Pay Quarterly Taxes & Stay Organized
There are many benefits to paying taxes quarterly, and it’s something up-and-coming freelancers might want to consider.
Noah Cammann, the founder and CEO of Cofes, recommends paying quarterly taxes because it allows you to avoid paying interest on any tax debt. It can also improve your credit score. “By paying your taxes on time, you will demonstrate to lenders that you’re a responsible borrower who takes care of his financial obligations,” says Noah. “This will help you get more favorable terms when borrowing money in the future.”
Staying organized is vital. “One way to organize your tax materials is to create folders for each type of tax,” Noah tells Play Louder. “This way, you will have an easy way to locate the documents that relate to your specific taxes.”
For all those new freelancers out there, Noah’s advice is simple: “Be patient, and don’t get discouraged if things don’t go as planned at first.” You should also be sure you understand the differences between independent contractor taxes and how you were previously taxed as a full-time employee.
Finally, depending on your situation, you might consider incorporating yourself. Doing this can help with tax planning and provide protection for your personal assets against lawsuits.
Of course, you will be best served by discussing all these issues with your CPA.
Stay on Top of Income and Expenses
Staying organized starts with itemizing all your income. As an independent contractor, income includes all royalties received, money for services, items and services bartered for work performed, and all virtual currency received for work performed, according to tax expert Beth Logan. These documents might include 1099-MISC, 1099-NEC, and 1099-K.
Beth works as a tax advisor for Kozlog, a company that offers consulting in addition to advice and planning, audit representation, and return preparation.
To help keep track of everything, Beth breaks down precisely what constitutes business expenses for freelancers. Expenses can include commutations, depreciation of capital assets, home office, vehicle work, and contract work for editing and artwork.
No one wants to file their taxes, but staying organized from the start of the year can make your life a lot less stressful at the end of the year, whether you’re paying altogether or paying quarterly taxes.
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This article was produced by Play Louder and syndicated by Wealth of Geeks.