Being an independent contractor or freelancer has its benefits: after all, you get to run your own business and retain control over your work day. You can become a digital nomad or create your own home office. However, it does have its drawbacks, and come tax time, you might find yourself struggling to make sense of your financial situation.
Determining Your Deductions
There are many ways you can minimize the amount of money you owe the IRS. Unfortunately, not everyone takes advantage of these deductions. Your tax deductions can include office space, office supplies, health insurance, travel expenses, hardware, software, internet and phone bills, professional development, and research materials. Essentially, anything you do that helps your job can be tax deductible. Consider hiring a tax professional if you’re unsure about how to approach your deductions.
Make Documentation a Habit
You might be accustomed to tossing receipts and other documents when you get them, but you should make record-keeping a habit. As previously mentioned, there are endless possibilities for deductions, but determining and proving those deductions is another story entirely. Have a filing and/or scanning system that accounts for all of your receipts and business expenses. If you don’t already have an accountant, now is a good time to start speaking to one.
Open a Health Savings Account
Independent contractors don’t usually benefit from health insurance offerings. Because of this, they’re responsible for handling their own health needs, and a health savings account is a great way to spearhead this.
A health savings account (HSA) is a great way for self-employed individuals to save for healthcare costs and pay for healthcare expenses without tax penalties or liabilities. However, an HSA is only available if you don’t have access to other insurance options. As an independent contractor or freelancer, your options for healthcare include the Affordable Care Act, COBRA, or coverage under a spouse.
Put Money Aside for Taxes
A traditional, pay-rolled employee pays their share of FICA, a federal payroll contribution that goes towards social security tax and Medicare tax. But independent contractors are responsible for handling their own taxes because they are paid for services directly, and therefore don’t have their taxes and other benefits removed from their income. You’ll always pay income tax like everyone else, as well as a self-employment tax.
Start off by estimating how much you’ll need to pay for taxes at the end of the year. You should put away between 25% to 30% of your income to go towards income tax and self-employment tax. Ideally, you’re sending in payments every three months and paying your taxes as you go.
No matter how much you make, at the end of the year, you’ll owe a certain amount of money in taxes. Owing the IRS can be overwhelming and intimidating, and even more so as an independent contractor. This can be very tough for independent contractors on low salaries. For example, if you only bring in $35,000 per year, forking over $8,000 of it can feel like too much at once. If you owe taxes, you can opt for an IRS installment agreement to help you manage your payments.
Start a Solo 401(k)
Bigger companies offer a 401(K) to their employees, but as an independent contractor, you’re tasked with doing this yourself. Starting a Solo 401(K) puts your retirement funds into your own hands. With a self-employed (401)K, you can put in high contributions and still benefit from tax dedication. Your spouse can also contribute to the account.
With this setup, you can put away large sums of money and benefit from much higher tax deductions. These plans also circumvent the the complex rules associated with traditional corporate 401(k)s, offering many investment opportunities Accountants can choose between after-tax Roth contributions or traditional tax-deductible contributions