Freelancers are their own bosses. But they are business-owners, too, and that means dealing with taxes.
Tim, a 28-year-old New Yorker, began his post-college career working as a freelance Web designer. Soon he was making good money and didn't see the need for a salaried job.
"I thought, 'What's the benefit? I'm my own boss, and I'm not hurting for jobs,'" he said. Moreover, he was still covered by his parents' health insurance.
That happy existence took a blow after Tim (who prefers not to use his full name due to embarrassment) visited H&R Block to file his income taxes. He brought the 1099 income statements from every job he worked. The tax preparer asked if he had paid quarterly estimated taxes. Tim didn't know what those were. Then he learned the hard way: He owed $8,000 in unpaid taxes from all those freelance jobs to the IRS.
In Pictures: Eight Money Tips For Freelancers
Welcome to the world of freelancing. It's a type of work well known to decades of writers, graphic designers, film editors and photographers. These days, this form of employment is making its way into industries where full-time jobs were previously the norm. It's not surprising to find lawyers, real estate agents, architects and engineers who are taking freelance assignments until they find a permanent job.
Like Tim, many workers new to this way of making a living don't realize that they are going to be responsible for things that full-time workers never need worry about.
"Some freelance workers fail to recognize that they are now basically running their own business," said Mark Luscombe, a tax analyst at CCH in Chicago. As such, they must estimate how much they'll owe and pay taxes that full-time employees have taken out of their paychecks automatically.
Freelancers will also owe self-employment taxes. Work for a company full-time, and it is responsible for kicking in half your Social Security and Medicare taxes. Go freelance, and you're on the hook for the entire 
amount--15.3% on top of income taxes.
They'll also need to estimate what tax bracket they'll fall into for the calendar year and take out the appropriate amount of taxes as well. For example, an unmarried self-employed lawyer who estimates he'll net $30,000 (after legitimate business expenses) by the end of the year should figure on setting aside a bit less than $3,000 for federal income taxes. The math works like this: A single taxpayer gets to subtract a standard deduction of $5,700 and a personal exemption of $3,650, leaving the lawyer with a taxable income of $20,650. The first $8,350 of that is taxed at 10% and the next $13,300 at 15%. Don't forget to put aside money for your state income tax too. You can find your state's rate by going to the Tax Foundation, a tax research group in Washington, D.C. "
Any freelancer who makes more than $1,000 a year should plan on paying estimated taxes every quarter using the IRS form 1040-ES, Luscombe suggests. The IRS requires estimated taxes to be filed by the 15th of January, April, June and September each year. If your payment is late or isn't as much as it should be, the government can charge a penalty of 3.5%, based on the amount you owe. Underpay by $1,000, and you could be stuck with an extra $35 fee.
Operating a freelance business has tax advantages too. You may be able to deduct legitimate business expenses like business meals, gas and costs associated with a home office devoted full-time to your self-employment activities. The IRS publishes an annual list of acceptable business deductions. States and cities have various rules regarding what you'll have to do to register your business and qualify for tax deductions.
How to keep all of this straight? Luscombe suggests that you keep separate bank accounts for your business and personal expenses. A high-yielding savings account is one good place to park your estimated tax payments before they are due.
In Pictures: Eight Money Tips For Freelancers
More From Forbes.com:
Six Ways To Save Money At Your Job
Seven Retirement Mistakes Young People Make
Eight Ways To Cut Your Health Care Costs
2 comments