The term "freelance" comes from the works of Sir Walter Scott and refers to traveling knights offering their services in battle to noblemen for a fee. This colorful designation is now used for independent contractors who offer their services to companies but are not officially employed by them. The freelancer is free to work in whatever manner they would like in order to accomplish the task given to them.
It is easy to see the benefits to working for oneself. However, a freelancer must quickly learn how to run all the aspects of their business. Unlike employees, a freelancer is expected to calculate and pay their own taxes. This is difficult task, but there are advantages to this financial control.
What is a W-2?
A W-2 is a statement that an employee receives from their employer at the end of a year. It lists their gross wages, taxes withheld, insurance payments, and other transactions made between the two parties. The company has already sent the employee's income taxes to the IRS and usually has paid some of the social security tax. The employee uses their W-2 to file their taxes for the last tax year. They may need to add additional income received from investments or independent work. The forms aid them in calculating their taxes and determining whether they owe taxes or will receive a refund.
What is a 1099?
A 1099 is a statement that an independent contractor receives from a company. It is simply a form showing how much the individual has been paid by the entity. There have been no taxes withheld and no other deductions. The freelancers are completely responsible for filing and paying their own taxes based on their income.
An employer of an independent contractor is required to file a 1099 form with the IRS if they pay the worker more than $600. This is so the IRS is aware that the freelancer is receiving wages and can make sure the taxes are paid.
Filing Self-Employment Taxes
Switching from receiving a W-2 to a 1099 may seem like a lot of added trouble during tax time, but there are advantages to having control over how the process. Those who pay self-employment taxes are subject to a tax rate of 15.3%. Those who make under $400 do not have to pay taxes at all. The rate is not flat. It is adjusted according to the net income of the individual subject to their filing status. An independent contractor uses the 1099 and other records to calculate their net income and taxes. This works much in the same way for those who file with W-2s, but the tax is not overpaid because of an estimate on the part of an employer. Therefore, the 1040 form a freelancer files at the end of the tax year will calculate the correct taxes for the calendar year without any overpayment. The American pay-as-you-go tax system that requires employers to regularly make payments to the IRS on behalf of their employees also compels freelancers to make quarterly tax payments. Independent contractors who estimate they will owe more than $1000 in taxes over a year must complete a worksheet of four estimated payments and pay them throughout the year. Unlike those who pay taxes automatically, freelancers have the freedom to predict changes in working situation. If the estimate is wrong, the taxes can easily be adjusted upon the next payment or the end of the year.
Know Your Limits
Freelancers have to dabble in every area of business. Although issuing invoices and managing expenses becomes easier overtime, some tasks are not worth the effort. As a business grows, chances are the tax filing procedure will become more complicated. A freelancer with a booming business should know when to outsource work to others. Hiring an independent CPA to take care of the quarterly taxes is fairly painless if one can provide good records. Focus on finding a preparer who has experience with independent contractors. The small fee could end up saving money and a lot of extra work.
For day to day operations, an option might be to outsource your invoicing and receivables to a third party. Having an experienced firm bill your clients and do your collections may be worthwhile, as your time is better spent focusing on what you do best. Besides, it can help maintain good client relations to have someone else be the collections "bad cop." Some companies can even handle your quarterlies for you. If you struggle with your back-office operations as an independent consultant, look into outsourcing some of your business administration to an experienced professional services firm.
What are the advantages of Freelancing?
Those who freelance have complete control over their finances. They are allowed to file their taxes in order to take full advantage of their deductions and business expenses. Those working under an employer may not claim the same tax credits unless the employer is a certain kind of umbrella company, or "portable employer of record" specifically designed for independent consultants and freelancers. The freedom to be involved in their finances from beginning to end may be extra work, but freelancers often avoid overpaying taxes.
Independent contractors should make sure they save money to make their estimated payment at the end of the year. This might take some self-discipline, but at least a 1099 makes this an option. With some financial planning, and perhaps some help from experts, freelancers can breeze through tax time and avoid costly IRS penal.
About Author: Stephanie Larkin is a freelance writer who writes about topics pertaining to employment opportunities and employment options such as Independent Consultant | Independent Contractor
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