Managing Freelance Finances: Income, Taxes, and Retirement

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Getting started as a freelancer? In addition to figuring out how to build your own business model, network, reputation, and workflow, you’re also going to have to take full responsibility for every aspect of your finances. There are plenty of downsides to working a regular 9-to-5 (as I’m sure you know given that you’re considering leaving it), but one of the biggest upsides is having employer support for a lot of the nitty-gritty financial details: making sure your paychecks are delivered to you in a timely manner, sending off your income tax with every paycheck so you basically don’t need to think about taxes until April, and providing a retirement plan for you.

Managing freelance finances can seem intimidating at first if you’ve never done it before, but once you learn the basics, you’ll be in the swing of it in no time. To get you started, here’s a brief beginners’ guide to freelance income, taxes, and retirement savings.

Inconsistent Freelance Income

Let’s start with the obvious: A freelancer’s income is very different than income from traditional employment. Freelancers jump from job to job and client to client constantly; they do not have the consistency that comes with a regular full-time position. Beyond that, a freelancer’s income is often affected by the time of year, depending on what service the freelancer provides. So how do you plan financially when you can’t see very far into the future? Create a safety net.

It is absolutely necessary to have money set aside in case work slows down or a project’s funding falls through. This is not the same money you are saving to buy a house or a car with. This is money specifically meant to be used when your income slows. Making that distinction will relieve stress. If you really get stuck and need to tap into your “buy a car” fund, that’s fine. But initially setting up a separate emergency fund for day-to-day bills is important for staying above water in the choppy seas of the freelance life.

Think of it like this: If you take your average yearly income and divide by 52, that is your weekly income. You may not make that every week but, on average, that would be your weekly salary if you were at a full-time job. Having a safety net fund is simply preparing you for inconsistencies in your week-to-week.

How Much Should I Save?

Every industry has its own thoughts on whether you should have one month, three months, or six months worth of rent stocked away in a savings account.

In my opinion, there are a couple of factors:

  1. What are your monthly bills in relation to your average income?
  2. Are there times of the year where you constantly have high-paying jobs and other times when you have no work, or do gigs tend to be consistent?
  3. How many paychecks are taking out taxes vs. how many will you have to pay taxes on later down the line?

Your first couple of years in the freelance world are hard to predict. You haven’t gone through it before. The natural ups and downs of work influx are a foreign concept. You also haven’t been through many tax seasons as a freelancer so you may not understand how much or how little you will owe in federal, state, and local taxes. My advice would be to start saving what you can. Keep setting aside money as a safety net. Then, as the years go on, you’ll start to learn how much you personally need to have in the bank for job lulls and tax season.

Managing freelance finances.
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Are Taxes Being Taken Out of My Paycheck?

You’ve been freelancing for six months and may be thinking, “Wow, I’m making way more in a day than I would be at a full-time gig.” Don’t forget about taxes! In addition to factoring in work inconsistencies, you also have to consider taxes. As a freelancer, you may be getting paid a pre-taxed amount. This means that you’re going to have to pay a bulk of money in federal, state, and local taxes. Plan accordingly so you’re not caught by surprise!

Freelance Taxes: Two Main Types of Work

As a freelancer, there are a number of ways you may be getting paid for your work. In thinking about taxes, it is important to distinguish between whether you will be receiving a Form W-2 from your employer.

Form W-2

If your weekly paychecks have had money taken out for income taxes, social security tax, and/or Medicare tax, your employer should file a Form W-2. Oftentimes this form will be mailed to your home or made available online around the tax season. It provides a breakdown of the various taxes that have been withheld over the past year from your paychecks. The form also provides you with the amount of “wages, tips, other comp” you’ve made over the year; this is your taxable income from that job. When it comes time to file your taxes, that W-2 gives you a lot of important information.

The W-2 is common for full-time positions. If you are a freelancer receiving W-2s, make sure that you get one from all applicable employers. Now, if you are freelancing for clients and being paid a rate in which no money has been removed for income tax, social security tax, or Medicare tax, it is unlikely that you will receive a W-2.

If you are working on a grant-based project, make sure that you are aware of whether taxes are being taken from your paycheck. This may vary depending on the grant, so don’t automatically assume one way or the other.

1099 Form

For work where you will not get a W-2, it is very important that you personally keep track of the money you make throughout the year so that your income information is readily available at tax season. If you are working for an employer as an independent contractor, you may receive a Form 1099-MISC from that employer. Regardless, it is best to track your income as opposed to relying on the receipt of 1099s because an employer is only required to provide this form if they have paid you $600 or more over the course of a year.

It is very likely that a freelancer will have a mix of jobs — some that provide W-2s, some 1099s, and some nothing. As long as you responsibly document all your work and payments, this mix of jobs shouldn’t cause too much of a paperwork headache.

Paying Federal Taxes: What Tax Forms Do I Need?

As a freelancer, more often than not, your work will be categorized as “self-employment.” (For the purposes of this article, we’re focusing on individuals, not on an individual working under the umbrella of an LLC.)

As noted earlier, some employers will be providing Form W-2s that break down information needed to file your taxes. But what do you do about the other work? The clients/employers that haven’t been removing money throughout the year? Below are the forms needed for straightforward, basic freelance gigs where you provide a service, clients pay you a rate, and now you need to pay the appropriate amount of federal taxes on that income.

Form 1040: Annual Income Tax Return

Everyone fills out a Form 1040 when filing their federal tax returns. Before completing this form, individuals filing under self-employment need to complete a Schedule SE supplement, which is described below. The W-2s will be needed to fill out the Form 1040 form as well.

It’s easiest to think about the Form 1040 as the master document that uses additional forms to help calculate various scenarios related to individual income**. A Form 1040 is factoring in all income whether taxes have or have not been removed from your paychecks. From this information, the Form 1040 will determine the amount you owe.

**Remember, we are talking about basic freelance work as an individual. There are numerous other scenarios that may require supplemental forms in regards to individual income (i.e. ordinary dividends or income from an estate).

Schedule SE: Self-Employment Tax Form

This is where an individual freelancer differs from a traditional full-time employee. To help complete the Schedule SE, refer to your 1099s and your personal tracking list of income you’ve made throughout the year (not including the income covered in the W-2s). To complete the Schedule SE, you also need to figure out whether you are filing a Schedule C for Profit or Loss From Business.

Schedule C: Profit or Loss From Business

This is the form people are referring to when they say, “maybe you can claim that as a business expense.” Among other things, this is where your list of deductibles goes. The IRS provides online instructions for each tax form, including the Schedule C. It can sometimes be difficult to figure out what counts as a deductible so take a close look at their guidelines. Laws may change year-to-year, so remember to stay updated. Once you complete this form, you will report the information on your Schedule SE where it will be factored into the calculation of self-employment tax.

More Complex Businesses

The more complicated your business, the more forms you may need to file. As your business expands into a more complex area, it may be worth hiring an accountant to help you with the process. Right now, we are just talking about the most basic of freelance work.

Don’t Forget State and Local Taxes

Filing state and local taxes will be different depending on where you live, so make sure to research your specific hometown to make sure that you send in all the required forms.

Managing freelance finances.
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“Quarterlies,” a.k.a. Estimated Taxes

Since taxes are not being taken out of your paychecks by an employer, a self-employed individual may be subject to estimated taxes. These are called “quarterlies” because they are generally paid across four different periods throughout the year. Since your employer is not removing taxes every paycheck, estimated taxes allow the government to receive tax payments on your taxable income in increments throughout the year as opposed to getting a larger sum each April.

There are a number of factors that go into whether you need to pay estimated taxes or whether you can wait until April of each year to pay everything at once. Usually, an individual freelancer needs to pay quarterlies if you owe $1,000 or more in taxes. If you are not sure whether you need to file quarterlies, read the IRS guidelines.

If you have to pay quarterlies, there is one large positive: They can make a freelancer’s personal financial situation easier to comprehend. Paying a little in taxes multiple times a year can be easier to prepare for than paying one large amount in the spring. In fact, there is even an optional choice to pay estimated taxes on a bi-weekly or monthly schedule.

DIY or Hire an Accountant?

This decision is completely personal. My advice would be to take a look at the Form 1040 and Schedule SE before tax season hits. Give yourself time to read everything and understand what is applicable to you. You may not even require a Schedule C, or you may need many additional forms than just the ones listed in this article. In terms of freelance, the forms needed are going to depend on the complexity of your work. But income doesn’t just mean freelance or full-time employment. As you start to buy stocks and make other large financial investments, filing your federal taxes is going to become more time-consuming. And again, don’t forget about state and local taxes!

So, can you file your taxes yourself? Of course you can! And the IRS provides an abundance of information to guide you. Will you hit a point when your taxes are so complicated that it may be a better time investment to hire an accountant? Most likely — especially as you get further into your career. Either way, it is crucial for a freelancer to understand how they are getting paid by each employer/client and how best to track their income, financial savings, and applicable deductibles year-to-year.

Saving for Retirement as a Freelancer

In addition to income and taxes, it is important for a freelancer to plan for their financial future by starting to save for retirement. Here is a quick explanation of the common difference between retirement savings in traditional employment and freelance work.

401K

When you are hired as a full-time employee, many companies offer a 401K plan. This is a retirement savings fund where employees can elect to have a certain amount of money taken out of their paycheck (pre-tax) every pay period and placed into a 401K where the money will be invested (usually at a low-risk). This money is placed into a retirement savings account where it cannot be used (without large financial ramifications) until the individual has reached a certain age. Oftentimes companies have a “matching program” where they will match an employee’s contribution to their 401K up to a certain percentage (i.e. a company may match up to 3% of an employee’s paycheck when placed into a 401K, so a $30 contribution would actually be a $60 contribution).

Roth IRA

As a freelancer, you should not miss out on retirement savings. Though you may not have the option of a traditional 401K, there is a similar tool called a Roth IRA. You can place after-tax money in a Roth IRA where it will be invested (usually at a low-risk) with the intent of leaving the money in the Roth IRA to grow over time. Once you reach a certain age, you will be able to withdraw money from the account without paying taxes on any earnings it has made from the investments.

With any investment, there is always the potential for loss. However, there is also a potential for growth. Research is key when planning for retirement. It may sound far off, but you’ll thank yourself later.

Own Your Finances

The more you read up and study each of these financial areas, the better prepared you will be to grow as a freelancer. As you get the hang of it, you’ll learn to confidently take control of your finances.

Author’s note: I’m not an accountant nor am I a tax expert. The tax information provided in this article is meant to be a jumping point for freelancers confused on where to start in the filing process. The IRS provides more in-depth information on their website. Necessary forms needed for federal taxes may vary depending on an individual’s business. This article was published in 2018 and is based on the federal tax information from the 2017 filing period and the current information on the IRS website.

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