For many people with full-time jobs, filing taxes requires little more than submitting W-2s, since full-time employers deduct taxes from paychecks. Freelancers, on the other hand, have no money withheld from their payments, and this lack of withholding is a huge reason why, when you're a freelancer, accounting involves so many moving pieces that can be tough to understand and track.
For starters, as a freelancer, you'll need to properly organize personal and business expenses so you don't confuse one with the other. Additionally, you'll pay quarterly taxes to make up for the lack of money withheld from your payments. And if you're new to freelancing, or you experience a large shift in your annual freelance income, you'll also pay one large lump sum of taxes on or around Tax Day.
If this all seems overwhelming, rest assured that many technologies exist to make accounting easier for you. If you master the basics of freelancer accounting before using these technologies, you should have minimal issues when it comes time to file your taxes.
Freelancer accounting basics
As a freelancer, chances are that none of your clients are withholding tax money from your paychecks. Therefore, you'll need to track all money your clients pay you so that, come tax time, you don't accidentally underpay your self-employment tax. This tax includes federal income tax and your contributions to Social Security and Medicare, all of which full-time employers automatically withhold from their employees.
Although your clients won't withhold money from their payments to you, they're still legally required to report the amount they pay you to the IRS. To make sure they can properly do so, you'll need to file your Form W-9 with each of your clients. This form shares your Social Security number or Taxpayer Identification Number with your clients so they can successfully inform the IRS of their payments to you. Unlike a Form W-4 that you'd file with a full-time employer, a Form W-9 signifies that you're a freelancer working as a separate business, not a full-time employee.
Any clients who pay you $600 or more during a calendar year will use your Form W-9 and income information to issue you a Form 1099-MISC or 1099-K. (You'll only receive the latter if you take payments by credit card.) Your clients will also file these forms with the IRS to show how much they've paid you, so it's crucial that you include all 1099 forms with your tax return.
Perhaps more importantly, you'll still need to report all of your non-1099 income on your tax return. Your income comprises all the money that you earn, not just money that your clients report to the IRS. For example, if one of your clients pays you less than $600 during a calendar year, you still need to include this amount in your yearly revenue. You can ensure that you properly tally your revenue by tracking and monitoring all your income.
What do freelancers and independent contractors need to track?
Freelancers and independent contractors need to track each and every dollar they earn, whether this money is reported on a 1099 or not. You should log your client's name, the amount paid, the project title, the date paid and the invoice number (as well as a copy of the invoice).
Since taxes, Social Security and Medicare are not withheld when your clients pay you as a freelancer, you may have to pay your taxes on these earnings in one large lump sum. Alternatively, freelancers who earn over $1,000 per year are encouraged to split this large one-time payment into four evenly sized, more affordable quarterly income tax payments. (Penalties may apply if quarterly taxes are not filed.) The amount of these estimated quarterly tax payments is determined using Form 1040-ES.
Several software platforms can help you estimate your quarterly taxes and keep track of all your earnings. These platforms can also allow you to maximize your tax deductions. To achieve the largest possible tax deduction, you'll need to track all your business expenses and keep organized, detailed receipts for them. As a freelancer, you may be able to write off business expenses such as advertising costs, office supplies, travel and more. You will list all your business expenses and deductions on Schedule C (Form 1040) of your tax return.
As a freelancer, you should also take extra care to properly organize personal and business expenses without accidentally categorizing one as the other. It will be vital to have an accurate tally of expenses when you calculate your net income, which is your revenue from all 1099 and non-1099 sales minus your expenses. If you accidentally include personal expenses in your business accounting, then you may report an inaccurate income to the IRS, potentially raising red flags on your tax return and leading to a dreaded IRS audit.
Best practices for freelancers
It's one thing to know that you have to track all your income. It's another thing to do so in an organized manner. There are several best practices for freelancers that can help you do so.
For starters, make a list of information categories that may be crucial to your tax return, and commit to filing this information in your logs immediately upon receiving it. This information may include client payment amounts and invoice numbers, travel expenses, transfers from business bank accounts to personal bank accounts, office rent (including home rent and utility bills if you work from home), receipts for office purchases, website hosting, and more.
To aid your organizing efforts, be sure to keep your personal and business assets separate. Many freelancers find this part of bookkeeping challenging, but with the right financial tools and accounting software, it couldn't be easier.
How to keep personal and business expenses separate
To keep your personal and business expenses separate, open a new checking account that's just for your business. Direct all your client payments to this account, and use the debit card associated with this account to pay for all your business expenses. If you own any business-specific credit cards, use your business checking account to pay off these credit card bills.
Separating your two bank accounts not only helps you organize personal and business expenses and payments, but it usually makes saving enough money to pay your taxes much easier. It also ensures that your accounting software will more accurately track your earnings, expenses and estimated taxes.
Why bookkeeping software is crucial for freelancers
With bookkeeping software, you can automatically link your business checking account to your software so that all your income and spending are automatically logged. You can use bookkeeping software to quickly, easily categorize all transactions as well. Most bookkeeping software also allows you to maximize your tax deductions and automatically calculate your estimated quarterly taxes.
Other platforms go the extra mile in automating your bookkeeping. QuickBooks Self-Employed, for example, allows for automated invoice creation and sending. Instead of laboring over these forms and having to remember to send them, QuickBooks Self-Employed does all the work for you. It also helps you to enable online payments from clients and sends notifications to overdue clients.
QuickBooks Self-Employed is especially useful for freelancers with extensive travel expenses. The QuickBooks Self-Employed app uses your smartphone's GPS to automatically track your miles when you travel, so whenever you're on the move for business purposes, you can log a business trip and use the mileage calculated to discover as much as 45% more deductions.
If you want to maximize your tax deductions and minimize the time you spend bookkeeping, QuickBooks Self-Employed is currently offering new users half off on their first three months. Click here to sign up and discover thousands of dollars in tax savings you might not find otherwise.