As I mentioned in a previous post, a freelancer is really a small company. As an independent contractor, you are responsible to estimate and pay your own taxes (usually 4 times per year unless you are just starting out). If you work for a company, they take taxes out for you, but as a freelancer you have to do this yourself. Don’t worry, this sounds scarier than it really is. One disclaimer here. I’m an artist and an entrepreneur, not a tax specialist or a CPA so please contact one before you implement any of this advice.
I highly recommend finding a good CPA (Certified Public Accountant) to help you with this. They can give you guidance on how to track your expenses, estimate quarterly taxes for federal and state payments, and help keep you on track with all things tax related. It’s really not that difficult, especially when you have a CPA.
If you are just starting out ask around to see what CPA’s your friends and family use. Or check your local Better Business Bureau or Chamber of Commerce to see what CPA’s are listed in your area. Meet with a recommended CPA (or 2 or 3) in person to ask questions and see if you feel like they are a good fit to help you.
You should expect to pay a few hundred dollars per year for CPA tax planning as a freelancer. It’s money well spent to keep you on track and to allow you to spend your time generating income.
There are 2 basic things you need to track as a freelancer: income, and expenses. We use Quickbooks for my company. It’s pretty easy to set up a company with it and begin tracking income and expenses. There are other software packages to use or you can even track income and expenses in a spreadsheet to give to your CPA. I prefer Quickbooks because you can send estimates and invoices to clients with it and you can generate several different types of reports to give to your CPA and for your own planning purposes.
The purpose is to track income and expenses so you can deduct expenses from the income to determine a final income amount you need to pay taxes on. For a freelancer, this is tied to your personal taxes so there are many factors which vary from person to person including tax bracket, marital status, dependents, wether or not you also have w-2’s from part time or full time employment, and geographical location.
As a general rule, when I’m budgeting projects I assume 25% will ultimately go to taxes. Ouch. Yes. That hurts. Embrace it. Again, your CPA will help you with quarterly tax planning (which means once every three months you pay a chunk of taxes to federal and state), but it’s good practice to set aside 25-30% of every payment you receive to have for taxes. The last thing you want to do is get to the end of the year and find out you owe more than you have set aside. Been there. Done that. Not fun.
Depending on your specific situation, your taxes may not be this much but it’s better to set more aside than you need to. As a freelancer or small business owner, cash flow is life and death for your endeavor. Plan ahead and plan for murphy’s law to kick in. Murphy always shows up at some point so be prepared. Having cash set aside for taxes and unplanned dips and emergencies is wise and will serve you well as a freelancer.