73% of U.S. workers say that they will either start or continue freelancing in 2023. That’s almost 3 out of every 4 workers. For hiring managers, agencies, and any company that outsources work – understanding how freelancers manage their businesses is critical. One huge element of being a freelancer is understanding taxation, and as a business that works with freelance talent, it’s worth giving yourself a quick refresher on the rules and regulations in the United States.
This is part of a series of articles about how to pay an independent contractor.
Learn more in our detailed guide to kyc check.
Why is Understanding and Managing Taxes So Important for Freelancers?
The IRS expects all freelancers to report all of their income. If your freelancers are used to working as employees before they launched their new self-employed life, they might be under the impression that your business is handling their tax obligations for them. Time for that wake-up call, it’s important to specify in your contract that they will be wholly responsible for all of their taxes – federal, state, and local.
If your freelancers do not pay their taxes, they can be subject to hefty fines and penalties, plus the headache of paying back all of the tax that they failed to pay at the time.
Types of Tax Freelancers May Need to Pay
It’s important to explain to your freelancers that they may be subject to a wide range of taxes, depending on the nature of their work and where they live.
Federal Income Taxes
Freelancers pay federal income tax based on their net income. They are able to make deductions on this income for reasonable work expenses, including their home office, utilities, internet and phone, business and technology costs, health insurance, and marketing and advertising. Federal tax will vary by national tax brackets and filing status, with seven tax brackets between 10% and 37%.
Self-employment Taxes
When you work as an employee, your employer pays half of your Medicare and Social Security taxes, but as self-employed, your freelancers will be responsible for both halves. The current rate for self-employment tax, or Social Security and Medicare taxes is 15.3%, made up of 12.4% Social Security and 2,9 Medicare.
State Income Tax
Most states require residents to pay income tax, which is paid directly to the state’s tax department and paid quarterly. The only states which do not have income tax regulations are Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming. Freelancers will need to file a state tax return as well as their federal tax return.
Local Tax Laws
Some local regions will have their own expectations for income tax, especially when it comes to Sales Tax. While freelancers will not usually be selling physical items, certain states require freelancers to collect sales tax on services as well as products. These are New Mexico, South Dakota, Hawaii, and West Virginia. That means if your freelancers live in these states, they should have a tax permit in order to sell services, even if there isn’t a physical product in sight.
Tax Tips Every Freelancer Should Know
Want to delight your freelancers and make filing time of year easy as pie? Share this easy checklist that can help them through the pain of accounting season.
- Set aside a percentage of your earnings: Don’t wait for tax season to roll around, regularly set aside between 25-30% of your earnings and put it in a specific account, so you’re not left scrambling when April rolls around.
- Mark the calendar: April 15th is the deadline for filing taxes as a freelancer or independent contractor. If this is a weekend or public holiday, it gets pushed, but this is when you need all your ducks in a row.
- Mark the calendar again: January 15th, June 15th and September 15th are the extra dates to keep track of if you’re filing quarterly, or filing estimated taxes. Same rules apply for public holidays and weekends.
- $400 is the magic number: No matter your expenses, if freelancers earn more than $400 a year, you need to file and pay taxes. Remember, you may still need to file if you make less than this amount – check the filing requirements if you’re not sure.
- $600+? It’s 1099 time: Each client that pays out more than $600 will need to provide a 1099-MISC or a 1099-NEC form. Relatively new to the party is the 1099-k form, that covers third-party network transactions, such as if the freelancer accepts payments via PayPal.
- Fill in the W9: To make things easier, insist that your agency or client gets you to fill in a W9, which will give them critical information needed for the 1099 forms. It will include your name, address, and TIN – the Taxpayer Identification Number.
- Keep an eye on the future: Freelancers aren’t given any benefits, which includes pension or planning for retirement. Take it into your own hands by opening a SEP IRA. Contributions are likely to be tax deductible, and future you will thank you for it!
Making it Easier on Your Business
Whether you’re an agency hiring dozens of freelancers, or an enterprise company with a handful, the chances are that freelancers are going to become an increasingly large slice of your strategy over the next few years. Understanding how freelancers pay taxes, as well as your own obligations isn’t something you can ignore.
Fiverr Enterprise is an end-to-end freelance management system (FMS) that gives you complete control over the hiring, payments, management and compliance processes of your freelance workforce. If you’re looking for a smarter way to manage freelancers, from tax and compliance through to milestones and payments – we should talk.
Related content: Read our guide to aml check.