Hate to break it to you, but this almost never happens to freelancers.
Because none of your income had taxes withheld, you’re going to owe a bunch by the end of the year. If you have a regular job and a small side job, you might find that you break even: The refund you would normally get from your W-2 income might cover what you owe on your 1099 income.
When you earn a lot of your income from 1099 work or from your gross business receipts, things get tricky. The IRS gets mad if you underpay your taxes throughout the year, and they’ll slap you with an underpayment penalty if you owe too much at tax time — the definition of adding insult to injury.
To avoid this, you can pay your estimated taxes quarterly. Sharpen your pencil and use IRS Form 1040-ES to figure out what your quarterly tax payments should be. This is done by making your best guess at how much you’ll earn over the year and following the directions to determine the taxes for each quarter. Then every three months you send a check (or have an automatic withdrawal) for that amount to keep up with your tax payments. At the end of the year, you’ll be able to list those payments on your tax form to offset the amount you owe. This also works for your state taxes, though you’ll have to check for the rules in your own area.
It’s not always easy to make an accurate guess about how much you’ll earn in a year, but a good rule of thumb is to use last year’s income and add ten percent just to be safe. The silver lining is that if you end up overpaying, you’ll get a refund.
Setting Money Aside for Taxes
One of the hardest parts about freelancing is being your own tax man. Every time you get a check, you have to keep in mind that it doesn’t all belong to you. To keep yourself from overspending and getting in a jam when you find out you owe money to the government, you should open a savings account dedicated to your tax savings. Each time you get paid, transfer the percentage of that check you’ll owe in taxes directly to the savings account. When it comes time to make those quarterly tax payments, you’ll be able to do so directly from this account.
And if you get a refund, you can keep it here, too, to avoid spending it on something frivolous. This way you have a solid cushion for your tax expenses, and you can even earn some interest on your money while it’s still yours — the major drawback of having income tax withheld from your paycheck.
Having a side gig means staying organized and keeping track of your cash, but the results are definitely worth it. Got any tips to share about tax time? Tell us in the comments!