How the IRS Taxes Freelancers

Freelancers often struggle with freelance taxes. Unlike traditional employees, freelancers don’t have taxes automatically withheld from their paychecks (unless they make an S-Corp election), making it essential to understand how the IRS taxes freelance income and how to plan accordingly.

To help, here’s a primer on what freelancers need to know about federal taxes and how to stay compliant while minimizing their tax burden.

(This post focuses on freelance taxation. If you want to learn more about business and entrepreneurship taxation, check out this post: How the IRS Taxes Entrepreneurs and Small Businesses.)

The Basics of Freelancer Taxes

Freelancers are typically classified as sole proprietors in the eyes of the IRS. This means that all business income and expenses are reported on the freelancer’s personal tax return. By default, freelancers fall under pass-through taxation, meaning the IRS taxes business profits as part of the freelancer’s individual income tax.

How Freelancers Pay Taxes

Since taxes aren’t automatically withheld from freelance earnings, freelancers must take proactive steps to pay their taxes correctly. Here’s how:

1. Set Aside Money for Taxes

Freelancers should set aside 15-30% of their profit throughout the year to cover tax payments. A dedicated business savings account can help ensure these funds are available when needed.

2. Pay Estimated Taxes Quarterly

The IRS requires freelancers to pay quarterly estimated taxes throughout the year. Knowing how much to pay, and where to pay it can be complicated. That’s why I recommend you speak with an accountant to ensure you are doing this correctly. 

3. File a Schedule C with Your Tax Return

At the end of the year, freelancers must report business income and expenses on Schedule C, which is attached to their personal tax return. This form calculates the freelancer’s net profit, which is then subject to income tax and self-employment tax.

Understanding Self-Employment Tax

One of the biggest tax obligations freelancers face is self-employment tax, which covers Social Security and Medicare. Traditional employees split these taxes with their employer, but freelancers must pay the full amount themselves, which is 15.3% of their net earnings.

The good news is that freelancers can deduct the employer-equivalent portion of self-employment tax when calculating their adjusted gross income, which helps reduce their taxable income.

The S-Corp Election: A Potential Tax Savings Strategy

Freelancers earning significant income may benefit from electing S-Corp tax status for their business. An S-Corp election allows freelancers to classify part of their income as a salary and part as a distribution, potentially reducing self-employment taxes.

• The freelancer must pay themselves a reasonable salary, which is subject to payroll taxes.
• Any remaining profit can be taken as a distribution, which is not subject to self-employment tax.

This strategy doesn’t make sense for all freelancers, so consulting with an accountant is recommended before making the election.

Business Deductions for Freelancers

Freelancers can lower their taxable income by claiming business deductions. Common deductible expenses include:

• Home office expenses (if the space is used exclusively for work)
• Business supplies and equipment
• Software and subscriptions
• Marketing and advertising costs
• Professional services (like accountants or legal fees)
• Travel and business meals (subject to IRS rules)
• Health insurance premiums (for self-employed individuals)

Keeping accurate records of these expenses is crucial for maximizing deductions and reducing tax liability.

Key Takeaways for Freelancers

• Freelancers must pay taxes on their own and should set aside money for tax payments.
• Quarterly estimated tax payments are required to avoid IRS penalties.
• Self-employment tax is 15.3%, covering Social Security and Medicare.
• An S-Corp election may reduce self-employment tax for high-earning freelancers.
• Business deductions help lower taxable income, so track expenses carefully.

Understanding and managing freelancer taxes is key to staying financially stable and avoiding unnecessary penalties. By planning ahead, keeping good records, and working with an accountant when needed, freelancers can stay compliant and reduce their tax burden.

*This article is general in nature and is not legal advice.