Picking up a side hustle or becoming your own boss full-time can have a significant impact on your life, including your taxes. If you engaged in any freelance or independent contract work last year, it’s essential to understand how to manage your taxes effectively. Here is a comprehensive guide to help you navigate some of the major tasks involved in handling your taxes as a self-employed individual.
Receiving payments from clients
One crucial aspect of managing your taxes as a freelancer is keeping track of the payments you receive from clients. Your clients may send you a Form 1099, which shows how much they paid you during the year. It is important to note that you will need these forms to calculate and report your income from your side gig.
If you receive a Form 1099, it is essential not to ignore it. The IRS also receives a copy of this form, so omitting this information from your tax return could lead to potential issues. Even if you did work for a client who did not send you a 1099, you are still required to report the income you earned. In general, all income, including cash payments, must be reported unless specifically exempted by law.
Making estimated tax payments
As a self-employed individual, it is crucial to understand that taxes are a pay-as-you-go system in the United States. Unlike traditional employees whose taxes are withheld from their paychecks, you may need to make estimated tax payments throughout the year. This involves estimating your tax liability and paying the IRS quarterly to avoid penalties and interest.
To make estimated tax payments, you will need to use Form 1040-ES. It is recommended to estimate your total tax liability from all income sources and adjust your withholding accordingly to automate the process and avoid the hassle of quarterly payments. If you are filing jointly with a partner who has a regular job, you may be able to simplify this process by increasing your withholding from work.
Filing your tax return at tax time
When it comes time to file your tax return, you will likely need to complete a Schedule C. This form is used by sole proprietors to report their business income and expenses. Filing your tax return as a self-employed individual may require more advanced tax software or the assistance of a professional tax preparer.
Taking advantage of tax deductions
Self-employed individuals can benefit from various tax deductions related to their business expenses. Expenses incurred in operating your business are generally tax-deductible, as outlined in IRS Publication 535. Additionally, you may qualify for the qualified business income deduction, which allows for a deduction of up to 20% of your side-gig income.
Understanding the taxes you might need to pay
Self-employed individuals are subject to self-employment tax, which includes a 12.4% Social Security tax and a 2.9% Medicare tax on net earnings. Unlike employees who split this tax with their employers, self-employed individuals are responsible for paying the full amount. To report and calculate self-employment tax, you will need to use Schedule SE.
Setting up your own freelancer retirement plan
As a self-employed individual, you may no longer have access to employer-sponsored retirement plans. However, you can set up your own retirement plan, such as a Solo 401(k) or a SEP IRA. These retirement accounts offer a way to save for retirement while potentially benefiting from tax-deductible contributions. By funding your own retirement account, you can reduce the amount you owe in taxes.
Hiring someone versus doing it yourself
Taxes can be complex, especially for self-employed individuals with a side gig. While hiring a professional tax preparer can be beneficial, it may also be costly. If you are confident in your ability to handle your taxes, you may choose to do them yourself to save money. However, if you are unfamiliar with tax forms and regulations, seeking the assistance of a qualified tax preparer or financial advisor with tax expertise is recommended.
In conclusion, managing your taxes as a self-employed individual requires careful planning and attention to detail. By following these guidelines and staying informed about tax laws and regulations, you can effectively navigate the tax implications of your side hustle or freelance work. Remember to keep accurate records, take advantage of available deductions, and consider setting up a retirement plan to secure your financial future.
