Learn How Much to Budget for Taxes as a Freelancer
Choose an option that suits your income flow.
Freelancing—it sounds like a wonderful way to make a living. You set your own hours and you decide how much money—or how little—you're willing to accept for your work. The autonomy and the freedom can be exhilarating, particularly when you're freelancing doing something you love.
Now take a deep breath and consider the reality: You're self-employed, so you must budget for taxes as a freelancer.
Self-employment comes with a whole host of unique tax responsibilities and issues, not the least of which is budgeting for the taxes you're going to owe the Internal Revenue Service at the end of the year. You don't have an employer standing by in the wings to conveniently lift money from your paychecks and send it off to the IRS on your behalf.
It can be challenging to calculate how much you're going to owe in estimated taxes as the year goes along, particularly if you're not sure how much you'll be earning—a common dilemma for those who are just starting out. But there are a few ways to do it. Here are some tactics you might use to budget for taxes as a freelancer and some things you'll want to keep in mind.
"Saving" for Taxes as a Freelancer
First, understand that "saving" is something of a misnomer here. Actually and ideally, the IRS will be saving for you because you should be sending in estimated quarterly payments every three months. You're effectively paying your taxes as you go, just as you would if your employer were withholding the money out of each of your paychecks.
These payments are due by certain dates because the IRS really wants to be paid as you receive income, or as reasonably close to it as possible. For the 2018 tax year, those dates are:
- April 17
- June 15
- September 17
- January 15, 2019
So you're not just plunking a portion of your income into a savings account, at least not for any longer than 90 days. But it's vitally important that you do set the money aside or at least have some alternate plan because the IRS has been known to apply penalties if you don't pay your quarterly taxes on time.
How Much of a Percentage Should You Save?
It's often recommended that you set aside 25 to 30 percent of your income. Yes, that sounds like a lot. But here's the thing: You're not just paying income tax. You must also pay self-employment tax, and your budget must cover both.
Self-employment tax is your FICA taxes—the Medicare and Social Security that your employer would normally withhold from your paychecks in addition to income tax. When you're employed, you pay half and your employer is obligated to pay the other half. But you are your employer when you're a self-employed freelancer. This means that you have to foot the whole bill yourself, and this is why it's known as the self-employment tax.
And it works out to a pretty significant percentage: 15.3 percent of the first $128,400 of income you receive in 2018, and 2.9 percent of anything you earn over this threshold. As an employed taxpayer, you would only have to pay half these amounts.
Twenty-five to 30 percent sounds more realistic now, doesn't it? Roughly half that percentage is attributable to your self-employment tax alone.
Calculating Your Income
Here's the good news: You don't have to save 25 to 30 percent of all your income because you have costs associated with running your freelancing business. You'll complete Schedule C at tax time, which will allow you subtract your business expenses from your overall freelancing income to arrive at your taxable income.
Keep track of your deductible expenses throughout the year, such as office supplies, travel expenses, mileage driven for business purposes, and perhaps maintaining a home office. You'll have to estimate if this is your first year as a freelancer, and it's typically safer to estimate low rather than high. Then deduct these expenses from your anticipated income and base the percentage you're going to budget for taxes on the balance.
Remember to save your receipts so that you'll be able to prove your expenses should the IRS ever ask about them.
Saving a Bit of Each Check
Now that you know how much you have to budget, you must decide how you're going to set this money aside. It takes discipline to save in advance and send in those quarterly payments. After all, you have to pay for groceries, heat, and the roof over your head, too. That being the case, it's usually easiest to set aside some percentage of each payment you receive as a freelancer.
This also saves you from having to guess how much you think you might earn over the course of the next few months. You'll just set aside a percentage of each particular payment you receive when you receive it.
The easiest way to execute this is to set up a savings account that you've earmarked for taxes. Link that savings account to the checking account in which you deposit your freelance income, then automatically transfer a portion of that money to the savings account each time you make a deposit.
An Alternate Way to Save
Depending on what you're doing to earn those payments and the frequency with which they come in, it can be a real headache to remember to transfer some of every single payment you receive. An alternate method could be to calculate how much money you earned last month, then set aside 25 to 30 percent of it before you begin paying the next month's bills.
Of course, this tactic assumes that you’re already saving some of your income and your account isn't empty, or won't become emptied when you transfer the tax money. Only use it if you tend to have ample extra money in your account at the end of each month.
Estimate How Much You Think You'll Earn at the Beginning of the Year
You can also estimate how much you think you'll earn for the entire year at the beginning of the year, then calculate 25 to 30 percent of that and divide by four going forward. This is the amount you'll remit to the IRS each quarter.
It might not be as difficult as it sounds if this isn't your first year freelancing. Each time you sign up with a new client, that client probably asked you to complete a W-9 with all your identifying tax information, such as your Social Security number or Tax ID number. Then, after the close of the year, you should have received 1099-MISC forms reporting the money each client paid you.
You can use these to form a good estimate of what you'll earn in the upcoming year. Has anything changed? Have you parted ways with one of those clients or are you doing more work for another? You can use the 1099s as a base, then adjust upward or downward to come up with a realistic idea of how much each will probably pay you this year.
If you estimate that you'll make $100,000 in net income after you subtract those business expenses, and if you decide to set aside 28 percent or $28,000 of that money, you'll have to save $7,000 per quarter.
But again, you'll need plenty of wiggle room in your finances and a fairly large cash cushion for this approach. Most freelancers prefer the first option, which is more of a save-as-you-go plan. It demands more management but less discipline, and it works within the realities of your day-to-day budget.
You Can Always Pay Early
Keep in mind that you don't have to wait until the quarterly estimated tax due dates to pay your taxes as a freelancer—you just can't go beyond these dates without incurring a penalty. If you're particularly flush one month, go ahead and pay your taxes early. The IRS won't mind. You don't have to let the money sit in your savings account waiting for September 17 to roll around, and it could avert disaster if you have a bad month or two and you come up empty when the due date arrives. You can look back at the month behind you, see what you earned, and pay monthly.