Many people are caught off guard when tax season rolls around after they’ve made the decision to head out on their own and become independent contractors or freelance employees. Generally speaking, most people enter the workforce and spend years of time as a W2 employee, where a large amount of the tax-related work is done for them by an employer.
The first thing people don’t consider when freelancing is the concept of estimated taxes. Freelance employees are supposed to pay into the system four times a year, all year round. This is accomplished by taking the total amount of money that you expect to make during a year and dividing the tax burden by four. If 90% of a person’s total tax burden for a calendar year isn’t paid by January 15, they could incur sizable financial penalties as a result.
Many people are so unfamiliar with the way freelance taxes work that they assume it to be a nearly identical process to traditional employment. When you’re a traditional employee for a business or organization, your employer takes taxes out of your paycheck each week. An employer typically takes out far too much, which is why so many people get refunds when tax season comes around. When you’re a freelance employee, nobody is taking out taxes of any kind on the money that you earn. If you make $10 doing freelance work, you always need to remember to take around $2 – $3 of that money and put it away for your tax payment.
Tax payers, even self-employed tax payers, pay for Medicare. Take a look at this video that describes that process and some other things about Medicare:
When you’re employed under traditional circumstances, an employer pays into Social Security and Medicare on your behalf. When you’re a freelance employee you are technically your own employer, which means that you’re responsible for Social Security and Medicare. Many people don’t quite grasp this concept and end up dramatically under-paying on their taxes as a result.
Making the jump to freelancing requires a person to take a significantly larger amount of responsibility for their own personal income taxes. Not only are a lot of people not necessarily prepared to do that, but a large number of people don’t even seem to fully understand what is required. Hopefully, this article can provide you a heads-up on some of this information.
If you have questions about best practices for paying your taxes as a freelancer, feel free to give us a call at (425) 483-6600!