Do I Really Have to File Taxes on my Freelance Income?
The short answer: Yes.
One of the most common misconceptions about freelance work is that you don’t have to claim this income or pay taxes on it. Whether you are freelancing full-time or on the side, chances are you will need to file. But how do you know for sure? It all depends on how much you make.
This magic number can be confusing, especially for first-time freelancers. While the federal minimums state that a single person does not have to file taxes if they made less than $10,350 in the year 2016, this figure does not represent freelancers and other self-employed workers. If you freelance on the side of another job, you are required to file income taxes on all of your income if you made more than the federal minimums. But if freelancing is your only source of income, you are only required to claim your freelance income if you made more than $400 that year after business-related deductions. (Yep. You read that right. $400.)Why $400? Because that is the minimum amount of income for self-employment taxes.
(Note: You are always responsible for claiming your income. If you are unsure whether or not you should claim your freelance income, consult the IRS or claim anyway, just to be safe.)
What are self-employment taxes?
Per the IRS, “Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.” You can estimate your self-employment tax by using the Schedule SE (Form 1040) form from IRS.gov. The self-employment tax rate can vary, but for the year 2016, it is 15.3% of your income, up to $118,500. If this is your first year freelancing, you will owe all of these taxes at one time, which can seem like a crushing blow to your finances, but after your first year of freelancing, you will be expected to pay quarterly taxes, which breaks up your tax payments into much more manageable payments. (To read more about quarterly taxes, check out 5 Things Every Freelancer Should Know About Quarterly Taxes.)
Don’t forget about deductions!
Remember, you only have to file taxes on your freelance income if you netted more than $400 after business deductions. So, if you made $1,000 freelancing but deduct $650 in legitimate business expenses, you do not have to pay self-employment taxes.
Now, before you try to deduct the entire cost of your house because that is where you work, there are some important things to remember when tallying your deductions. The IRS specifies that you can only deduct expenses that are necessary for your freelance business, and only the portion of those expenses that you use for work. For example, you cannot claim the entire cost of internet in your home for a year as a deduction, but you can claim the percent of your internet that is used for business purposes. But how do you figure that out? Let’s say you pay $65 per month for internet in your home. Divide that by the 720 hours in a month, and you pay $0.09 per hour for internet. If you work 40 hours per week at home, then you can deduct $3.60 per week or $187.20 per year for your home internet expenses.
You can also deduct for your home office, but this is a very complex deduction process that the IRS takes very seriously. If you have a room or a partitioned section of a room that is used primarily for work, you can deduct a percent of your mortgage or rent, property taxes, utilities and insurance. But if you deduct for a home office, be prepared to defend this deduction if you get audited. You must use your home office for work and nothing else, so your living room or dining room do not count. Even if you work primarily in those rooms, that is not the primary purpose of those rooms, so they cannot be deducted.
You should absolutely deduct your business related expenses on your taxes, but remember that the IRS has very strict rules regarding these deductions, so you should have documentation for all of your deductions and keep that documentation with your tax returns for that year.
Wait…am I being double taxed?
In essence, yes. But it is more complicated than that. As a self-employed person you are being taxed as both a worker and a business, but you can still get an annual income tax return. How much you pay and how much you get back will vary by person, of course, but don’t give up on freelancing because the taxes seem daunting! Freelancing is still a great way to make money on your own schedule once you figure out how to claim and file your taxes properly.
Filing taxes can be tricky under the best circumstances, and sometimes it is beneficial to enlist help. We understand that hiring a CPA may not be in your budget, but sites like TurboTax make it easy and affordable to file your taxes from your comfortable, tax-deductible home office. If you need more help during the year, check out our article on the 5 Must-Have Tax Tools for Freelancers.