Performing services for clients outside of a regular job can provide extra income to supplement wages or an avenue of full-time self-employment, but freelance work has several important tax implications. Freelancers or independent contractors are considered self-employed business owners for tax purposes. Your freelance income is subject to self-employment taxes, and depending on how much you earn, you may also be required to make estimated tax payments.
Self-Employment Tax Basics
The Internal Revenue Service defines an independent contractor as someone who offers her services to the general public and has the ability to control how he performs his work. Self-employed workers are responsible for paying self-employment taxes that fund Social Security and Medicare. In 2012, self-employed workers pay tax rate of 10.4 percent on the first $110,100 of income for Social Security and 2.9 percent on all self-employment income for Medicare.
Employers withhold a portion of their employees' pay and sends it to the government to cover the employees' tax obligations. If you're self-employed, no one withholds this money for you, and you are responsible for making sure you "pay as you go" on your tax obligations. The rules are complex and it's important to review which IRS rules apply to your situation, but for example, you may owe interest and penalties if you've underpaid your taxes by $1,000 or more by the end of the year. To avoid interest and penalties, you must make estimated tax payments on a quarterly basis. These estimated tax payments should include money for both self-employment taxes and income taxes.
The IRS offers a variety of tax deductions to freelancers for their legitimate business expenses. Examples of business tax deductions that may be especially beneficial to freelancers include a deduction for home office expenses, use of a vehicle for business purposes, business-related travel, and the cost of tools and supplies. For expenses shared between a home office and the rest of the home, like general repairs and utilities, the home office deduction is limited to the percentage of the home used as an office.
Freelancers who do not make much money doing freelance work during the year may not have to make quarterly payments nor pay self-employment taxes. According to the IRS, you must pay self-employment tax if you have net earnings from self-employment of $400 or more. This means that a worker that does one small freelance project during the year that produces less than $400 of income doesn't owe self-employment tax.
- Internal Revenue Service: Self-Employment Tax (Social Security and Medicare Taxes)
- Internal Revenue Service: Estimated Taxes
- U.S. Small Business Administration: Small Business Expenses and Tax Deductions
- Bankrate.com: A Dozen Deductions for Your Small Business
- Internal Revenue Service: Self-Employed Individuals Tax Center
- Internal Revenue Service: Like Share Print Independent Contractor Defined
- Social Security Administration: 2012 Social Security Tax Rate and Maximum Taxable Earnings
- Internal Revenue Service: Self-Employment Tax