Dave DiVerniero admits that when he started freelancing about 10 years ago, he didn’t use trial and error to figure what qualifies as a business expense when he did his taxes — it was mostly just error.
During his first full year of freelancing, he didn’t know he could deduct a home office even if it’s not a separate room, or that the miles he traveled to meet with clients counted as business expenses.
“When you file a return, [the IRS is] not going to tell you that you missed a bunch of deductions, so it was really just error until I educated myself,” says DiVerniero, who now runs a coaching website for freelancers called Freelancer Advocate.
In addition to deductions, there are many pitfalls to consider when filing taxes as an independent contractor, self-employed person or gig worker. One of the biggest traps is not knowing how much to pay the taxman.
So how much should you set aside?
What Kinds of Taxes Do Side Hustlers Have to Pay?
Taxes for side gig workers are a little different than those for regular employees. Taxes are not already taken out of a side hustler’s paycheck. That check is not all take-home pay.
It’s up to gig workers to pay their fair share to Uncle Sam.
If you look at a pay stub from an employee at a company, you’ll see federal income tax, Medicare tax and Social Security tax automatically withheld — often in addition to deductions for health care and retirement contributions. Employees usually have withholdings from their paychecks of 6.2% for Social Security and 1.45% for Medicare, a total of 7.65%.
For the self-employed, Social Security and Medicare taxes combined are a fixed 15.3% (also known as the self-employment tax). The reason this rate looks like it’s doubled is because employers pay the other half for employees. As a freelancer, you’re both the employer and the employee.
“When you’re self-employed, now you have to pay that full amount yourself, so you are liable for 15.3% of the net profit from your self-employment income,” says Jorge Soriano, a certified financial planner with GTE Investment Group.
But what about federal income tax? How much you’ll owe depends on how much you make annually doing your side hustle. In 2018, the tax brackets for a single filer are:
- 10% (Earning $1 to $9,525).
- 12% (9,526 to $38,700).
- 22% ($38,701 to $82,500).
- 24% ($82,501 to $157,500).
- 32% ($157,501 to $200,000).
- 35% ($200,001 to $500,000).
- 37% (Over $500,000).
Note: These brackets are based on “taxable income,” i.e. your income after you’ve factored in your self-employment tax and all eligible tax credits and deductions.
Unfortunately, that’s not all the taxes side hustlers have to pay. Most states require workers to pay state income tax and — in some areas — local income tax. Each state is different, so look up your state’s income-tax rate and find out if your city or county has an additional local income tax.
What’s Changed for the Gig Economy Under the New Tax Cuts and Jobs Act?
There are additional deductions freelancers can take advantage of due to the 2017 Tax Cuts and Jobs Act. The relevant changes are referred to in IRS lingo as the Qualified Business Income (QBI) deduction under section 199A.
“Simply stated, section 199A provides a deduction in the following amount: 20% of qualified business income,” says Luke Richardson, a certified public accountant, IRS enrolled agent and tax professor at the University of South Florida.
Richardson says these changes are a “terrific opportunity for participants in the freelance and gig economy” because almost all income generated through a side hustle counts as qualified business income.
Basically, as long as all of your taxable income as a single filer does not exceed $157,500 or $315,000 for joint filers (read: almost everyone), you can deduct 20% of your freelance income. And because this isn’t classified as an itemized deduction, there’s an added benefit: the standard deduction.
Most taxpayers qualify for the standard deduction, which varies:
- $12,000 for single filers.
- $18,000 for single filers who are the heads of households.
- $24,000 for joint (married) filers.
“Because the QBI deduction is not an itemized deduction, it may be claimed in conjunction with the standard deduction,” Richardson says — meaning you can stack both deductions to slash the amount of taxes you pay as a freelancer.
How Much Money Should I Set Aside for Taxes?
Drew DuBoff, a freelancer who coaches entrepreneurs on scaling their business, is usually cautious when saving for taxes. He sets aside 30% of his income for taxes every time he gets paid. Even though his self-employment, federal and state income taxes total less than 30%, he feels better having a buffer.
“I’d rather get a [tax refund] than have to pay more at the end of the year,” DuBoff says.
Experts recommend freelancers save 30 cents of every dollar for taxes. That way you’re not scrambling to figure out how to pay what you owe at the end of the quarter or year.
Soriano says the worst-case scenario of overpaying is that you get a refund. Even though you don’t want to give Uncle Sam too much of your money when those funds are not gaining interest, it’s easier to reassess your withholdings for the following year than end your first year in debt to the IRS.
Do I Need to Pay Estimated Quarterly Taxes?
Federal income taxes and self-employment taxes run on a “pay-as-you-go” model, Soriano says. That means people need to pay throughout the year as they earn money.
For employees, those taxes are withheld from their paychecks by their employer. But for side hustlers, it’s on them to pay quarterly. Every freelancer or independent contractor who expects to owe $1,000 or more in annual taxes needs to file quarterly taxes with the 1040-ES.
Below are the dates that estimated quarterly taxes are due for the following periods:
- April 15 for Jan. 1 to March 31.
- June 15 for April 1 to May 31.
- Sept. 15 for June 1 to Aug. 31.
- Jan. 15 for Sept. 1 to Dec. 31.
Please note that if a due date for estimated taxes falls on a weekend or a holiday, payments can be made the next business day and still be considered on time, according to the IRS. If you pay less taxes throughout the year than required, you’ll be charged a penalty.
What Forms Do I Need to File to Pay My Freelance Taxes?
As a side hustler, you are considered self-employed by the IRS, regardless of how much (or how little) you earn.
You should receive 1099-MISC forms from any businesses that paid you more than $600 in a calendar year. But you’ll need to report all income even if you don’t receive a 1099 — including if your side hustle paid you in gift cards or non-cash prizes.
Here’s the overview of tax forms you may need:
- Form 1040: Due to the 2018 tax changes, this is now the form used by all U.S. taxpayers to file an annual income tax return. Forms 1040S and 1040EZ are no longer available. (Many of the entries that were on those forms are now found in the schedules mentioned below.)
- Schedule C or C-EZ: Here’s where you, as the sole proprietor of a business, figure the net profit or loss for your business. If you meet the listed requirements, you can use the shorter EZ form. You’ll enter the final number on Schedule 1 (Form 1040).
- Schedule SE: This is the form you’ll use to figure your self-employment tax if your net earnings are $400 or more. You’ll enter this figure on Schedule 4 (Form 1040).
- Form 1040-ES: Use this form to figure and pay your estimated quarterly taxes.
Remember to track business-related costs you can deduct as an independent contractor. There are more expenses you can deduct than if you were an employee.
How to Simplify Saving for Taxes
Now that you know how much you have to set aside for taxes as a side hustler, it’s a good idea to open a separate business bank account. DuBoff says it can be challenging to sort through personal expenses to find business expenses at the end of the month from the same account.
Your business account can be the place to deposit all your side hustle earnings, pay expenses and put aside enough income for taxes. That way you’ll be in great shape on April 15 and keep your tax-related fears at bay.
“A lot of people get worked up [about taxes], but it’s a lot more simple than people think,” DiVerniero says. “Once you get a handle on it, it’s very straightforward.”
Matt Reinstetle is a former staff writer at The Penny Hoarder. Staff writers Tiffany Wendeln Connors and Adam Hardy contributed to this story.