Last tax season, following my first year as a freelancer, I got a wake-up call from the IRS: I owed thousands of dollars because I didn’t know that taxes weren’t being withheld from my pay.
Almost as bad as this startling oversight, I realized that when it came to taxes I was disorganized and unprepared to take advantage of the many deductions available to contractors. I vowed to not make the same mistakes for 2016, and I’ve been working hard all year to make sure I’ll be ready come April. Here are a few lessons I learned the hard way.
1. Use one payment system to receive income
This may sound odd, but figuring out what I actually earned in 2015 was a challenge. I had multiple sources of income: my full-time work as an independent contractor, other freelancing clients that I write for, and the stock market. I had no method to track it all, which left me scrambling to figure out exactly how much I’d earned.
My lesson learned: Using just one payment system prevents money from getting misplaced in cyberspace and helps you remember income that may not have been captured on a 1099 form so you can report it to the IRS. Many freelancers use PayPal, but another option is direct deposit. In this case, make sure to have all clients deposit into the same checking or savings account so you can more easily tally your total income for the year.
2. Track your expenses
The government allows self-employed people to deduct — or “write off” — business-related expenses, such as website domains, insurance, meals with clients, commuting, internet bills, home office supplies, and even rent. Not reporting office-related expenses is like pouring money down the drain. On the other hand, sometimes people deduct these expenses even though they don’t have receipts, which is illegal and problematic if you’re audited.
I didn’t know what my business expenses were in 2015 because my receipts were scattered or trashed. I consequently couldn’t deduct many legitimate expenses. I now keep an ongoing spreadsheet of business expenses, which includes the date of purchase, cost, what it was for, and where to find proof of purchase (the receipts). You can also use an app like Expensify or Receiptmate to take pictures of receipts, so you don’t have a mountain of old receipts crammed in a drawer.
3. Pay estimated taxes
I also didn’t realize that, in most cases, if you’re self-employed or an independent contractor, you’ll have to pay out your Social Security and income taxes at the end of the tax year, whereas if you were an employee, your company would automatically deduct these from your income. In other words, as a freelancer, if you accept a writing job for $100, you get paid $100 — there are no taxes withheld. I was expecting a refund but, since I was an independent contractor and no employer was withdrawing taxes from my paychecks, I actually owed thousands of dollars to the IRS for 2015. Talk about a downer.
If you’re self-employed, you need to file estimated taxes or you’ll face a fine. This means estimating your quarterly earnings (via form 1040-ES) for the upcoming year and sending a check to the IRS each quarter based on your predictions. If you’re wrong, you’ll be refunded or owe a bit more.
I like estimated taxes because I get a better grasp on my real income throughout the year. If you don’t want to file estimated taxes or don’t think you need to, make sure to have a savings cushion come April in case you owe money.
4. Get help
I didn’t do the three things above in 2015 for two reasons: ignorance and anxiety. If I’d worked with a tax professional from the start, I would have felt way more in control of my finances. (And that’s exactly what I did for 2016!)
Try to get your taxes done early. If you have complicated questions or feel like you need advice beyond just filing instructions, a tax pro can help. Since you started the process earlier, it will be easier and less stressful to find one.
Wells Fargo customers save up to $15 on TurboTax federal products. Plus simple filers file for FREE with TurboTax Absolute Zero®.
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