Tax Tips for Freelancers, Side-Hustlers, and the Self-Employed

by Sophia Bera on March 29, 2017

If you work as a full-time contractor or freelancer, own your own business, or earn income through a side hustle, your tax situation is going to be a bit different.

When you work as a W-2 employee, a portion of each of your paychecks automatically goes toward taxes and Social Security and Medicare payments. But when you strike out on your own, taxes aren’t taken out of your paychecks. It can feel like you’re earning so much more … only to owe a big amount at the end of the year.

As a self-employed person, I feel your pain! The best way to ease into paying taxes in this situation is to be as prepared as possible. I once again turned to John McCarthy, CPA, of McCarthy Tax Preparation for advice on how to handle your taxes when you work for yourself.

Be Smart About Banking

“The biggest thing I encourage for folks that are self-employed that I work with are to have separate bank accounts and credit cards for their business,” John said.

Especially when you first launch your business, it’s easy to default to using your existing personal accounts, but that can lead to headaches at tax time. For one thing, you run a greater risk of the IRS classifying your business as a hobby, which could lead to an audit.

Plus, when your personal and business expenses all appear on the same bank and credit card statements, combing through everything to find amounts to deduct will be a nightmare.

Keep Biz & Personal Accounts Separate

Save yourself time by taking a moment to open separate checking and savings accounts online. Ally Bank is one of my favorite options. While it doesn’t offer business banking, one-person operations can use Ally accounts for business transactions.

If you need specifically need a business checking and savings account, you will likely need to go into a bank branch to open up new accounts. Bring your LLC articles of incorporation and EIN if you have one.

I haven’t found a great fit for small business banking, so I usually go with one of the big banks that will sync with the online bookkeeping systems like QuickBooks and Xero. I love credit unions and small banks but they usually have a tough time downloading transactions into these bookkeeping programs, which becomes time consuming as your business grows.

Don’t Forget About Taxes

If you only take away one thing from this article, it’s this: pretty please set aside money for taxes!

Here’s one tip for you: create a second business savings account just to save up for your tax payments. Automatically transfer about 25-35% of your earnings to this account so you have money ready to go when a tax bill is due. You don’t want to be caught off guard by a large tax bill! (And if you have leftover money you can allocate it towards another financial goal, like a retirement fund for your small business!)

Track Your Expenses

Once a month, take 20 minutes to look through your business bills and make note of your expenses. Tools like Mint or Quicken can help, but an old-fashioned spreadsheet works, too. John recommends the free Excel templates from Vertex42.

Setting time aside each month for this task sounds like a drag, but believe me, it beats hours of catching up at the end of the tax year. Your record-keeping will be so much more accurate if you only have to look over a month of business expenses, rather than hunt for that conference registration payment from six months ago!

Know What You Can Deduct

When you’re self-employed, there are quite a few business costs that can be deducted from your taxable income. Getting in the habit of tracking your expenses each month will make it easier to keep a record of deductible business expenses.

Here are some deductible expenses:

  • Travel: This includes flights, hotels, and even mileage on your car (John suggests keeping track of your mileage by using an app like MileIQ — the IRS needs documentation of this if you get audited).
  • Credit card and banking fees: If you pay fees for your business accounts and credit cards (or if you invoice through PayPal and pay fees on your earnings), you can deduct them.
  • Professional licensing and education: This includes fees to keep your license current, conference and course fees, professional insurance to protect your business, and membership dues to organizations in your industry.
  • Business operations: Phones, internet access, a home office (this means a room dedicated to running your business — not your dining table!), hiring other professionals like lawyers or contractors, hosting your website, and more.
  • Health insurance: If you pay for your own health insurance, you can deduct 100% of your health insurance premiums. This isn’t a business deduction, it’s a personal deduction from your federal and state taxes.

Making Payments

Your business finances are organized! It’s time for the fun part: paying taxes. As you might have expected, you’ll owe federal and state taxes. But here’s something that surprises a lot of first-time freelancers: self-employment tax. This is made up of the Social Security and Medicare taxes that would have been deducted from your paycheck if you didn’t work for yourself.

If you expect to owe more than $1,000 to the IRS, you can make quarterly estimated tax payments. This can help you avoid paying a penalty for underpaying your taxes by the end of the tax year. It’s a good idea to talk to a CPA for help estimating your quarterly payments, but aim for payments of 25-30% of your net income.  

If you’re new to self-employment or contract work, your tax situation can be a bit more complicated than it’s been in the past. Having a great CPA on your side can be a huge help.

Sometimes people assume that I do my own taxes. No way! That’s the last thing I want to mess up. This year, I hired John.