I write about money for a living. You would think that fact alone would protect me against some, if not all, the surprises that come with paying taxes. But alas, the transition from salaried employee to employee with a side hustle and then to a full-time self-employed person came with a few stumbles.
Some were self-imposed. Some were lack of knowledge about the tax system. And some were based on down right bad advice. The truth is – taxes are never an easy thing to master when you’re first starting out.
To help you avoid some of the mistakes I made, here are the top five things I wish I’d known about paying taxes when I first started freelancing.
1. Not everyone will send you a 1099-MISC
When you work as a freelancer, the simple days of getting a single W-2 and filing taxes with one form are gone.
At the time I entered the freelance market, I knew to expect to receive a lot of 1099-MISC forms from my clients. I understood each of those forms reported the amount of income I earned from each specific payer.
But, what I didn’t know is that your client isn’t required to send a 1099-MISC if you earned less than $600. And there certainly were times I earned less than $600 from a single client. However, when you’re freelancing, you still had to report the income even if I didn’t receive the form.
I remember spending my first year waiting for all my 1099-MISC forms to arrive thinking I needed them before I could file my taxes. As I approached the filing deadline, I then realized some would never arrive. Luckily, I’d done a good job of tracking all my income, so I could accurately report it on my tax return without all the forms.
2. Save for city tax too
Common advice for those freelancing is to set aside 30 percent of each paycheck for taxes. In general, this advice is focused on paying federal, state and self-employment tax.
But, unfortunately, that wasn’t all I had to pay. I live in New York City, so I not only pay a high state tax, but I get hit with a city tax as well. For that reason, I bumped my savings up to 40 percent of each paycheck to account for additional taxes. Any money I had left over was put into a SEP-IRA for retirement.
3. Put money into a SEP-IRA
My career started in the traditional workforce where I had access to a 401(k). I contributed diligently to that account out of each paycheck. Additionally, I doubled-down my retirement savings efforts by putting money into a Roth IRA.
I started freelancing while working a full-time job, so my retirement savings strategy didn’t change in the first year. However, I quickly realized how much better a SEP-IRA was for my freelance income. And that became even clearer when I jumped to working for myself full-time.
SEP-IRAs have significantly higher contribution limits compared to the $5,500 allowed for a Roth IRA. I could put away the lesser of 25 percent of my compensation or $54,000 (TY 2017).
Right now, I’m not balling on over $200,000 a year (yet). However, 25 percent of my compensation is still a lot more than $5,500.
4. Paying a penalty doesn’t need to happen
The first year I needed to pay quarterly estimated taxes, I decided to ignore it until I filed my annual return for my full-time job. However, I always saved some of my freelance income to account for those taxes plus the anticipated penalty for not paying quarterly.
That’s right, I knew I’d have to pay a penalty and I still ignored filing quarterly estimated taxes.
This strategy was partly due to another freelancer telling me she found the whole thing too much of a hassle. She said paying the penalty was much less painful than the time spent figuring out how much she owed quarterly. I went with that mentality and used the excuse of, “my time is worth more and I’ll just pay the penalty.”
Fortunately for me, the penalty wasn’t too painful. But that’s only because I was still paying taxes at my full-time job at the time. But, in reality, that’s not the smartest excuse to use. Looking back now, my advice is to take the time to calculate and pay your taxes quarterly if you anticipate owing more than $1,000. That way you avoid a large tax bill and have to scramble to pay it.
5. Paying quarterly estimated taxes when freelancing is simple
Honestly, paying quarterly estimated taxes isn’t painful at all. I’m serious.
Plus, it keeps me accountable throughout the year to monitor for deductions and track my expenses. I can’t imagine how big of a headache that would be if I waited until the end of the year.
So, the ultimate thing I wish I’d known about taxes when I started to freelance was just how simple it really is to pay quarterly estimated taxes.
Photo credit: Erin Lowry
The post What I Wish I Knew About Taxes When I Started Freelancing appeared first on TaxAct Blog.