Understanding Your Taxes When Switching To A Career In Freelancing

The recent pandemic has been tough for the job market. The year 2020 ended with 780,000 Americans filing for unemployment. It is also the perfect time for many to consider a career switch or contemplate becoming their own boss. While freelancing was on the fast track before 2020, the pandemic has accelerated its growth, says a recent Payoneer report. Whether you were laid off or, furloughed, or want to start a second career, starting a freelancing career can prove to be both lucrative and flexible. That’s the main reason why 35 percent of the American workforce are freelancers- as a side gig or second career. However, along with the freedom that freelancing provides, it also comes with the responsibility of securing your clients and attending to federal business affairs like calculating and paying your taxes. If you are new to the freelancing world, your taxation obligations may seem complicated. Your best bet? Starting with a few key tax basics for freelancers.

Technically, freelancers are classified as self-employed under the U.S tax code since it does not recognize freelancers. As a freelancer, you will need to pay 2 different taxes: income tax and your self-employed contributions tax. The self-employment tax rate for 2021 is 15.3 percent. Some freelancers may also need to pay state or local taxes, so you should check with your state tax authorities. When judging whether you are liable for tariffs, it is best to follow the U.S tax law that relates that stipulates that if you earn more than $400 in income, you are liable to file a tax return. Your circumstances will also dictate your tax liabilities. If you are an employee and freelancing as a side gig, you will need

If your freelance income is less than $400 for the year, you may still be liable for tariff charges if you meet any of the additional requirements set out by the IRS such as receiving a health savings account or Medicare Advantage distribution. Another thing that will influence whether you need to pay taxes (and how much you owe) is your business structure. While most freelancers opt to file as sole owners, some may choose to operate as an LLC or corporation. If you do, you will also need to pay unemployment taxes alongside federal and state taxes.

Most taxation experts recommend setting aside 25 to 30 percent of your monthly income to cover your tax bill. It is also advisable that freelancers opt to pay their taxes quarterly. This helps you avoid a large tax bill to settle at the end of the year. However, if you want to accurately estimate your tax obligations you can also use IRS Form 1040-ES.

As a freelancer, you can either pay your taxes quarterly or annually. However, unlike employees, it is completely your responsibility to keep track of your taxes and corresponding paperwork throughout the year. Failure to report correct income or late payments can result in hefty fines and penalties by the IRS. To make the process a lot easier for you when filing, keep your business and personal finances separate with a dedicated bank account for your freelancing income.

You should also keep track of any business expenses and deductibles throughout the year by filing the receipts together. Costs like travel expenses and office supplies can be deducted when filing and reduce your tax obligations. Any freelancer should also become familiar with the safe harbor rule. According to the Safe Habour Rule, self-employed individuals that expect their income to increase should guesstimate 100 percent of the previous year’s income. However, if you earn more than $150,000, expected to pay 110 percent of the previous year’s tax charges.

These are just a handful of the best tips for paying tax as a freelancer. Navigating the tax maze is not done overnight, and best done by staying updated. It also differs greatly according to your path to becoming a freelancer. For instance, if you were unemployed at some time before launching your freelancing business or relied on unemployment benefits, you may also be able to capitalize on a $10,200 tax exemption for the year. Therefore, it pays (sometimes thousands of dollars) to stay abreast of self-employed tax developments.