As an employer, before you commit to hiring a freelancer, you must understand everything to do with freelance taxes to onboard and pay them free of any hassles.
This article will help you understand how they are filed based on categories, applicable forms, freelancer tax deductions, etc.
Disclaimer: The applicability of freelancer tax categories and forms varies from country to country. Hence, there are geographical complications due to local laws and statutory requirements. This article will cover freelance taxes, specifically in the U.S region.
So let’s dive straight into it.
How do Taxes for Freelancers and Employees Differ?
Now generally, taxes for freelancers v/s employees are primarily different because freelancers are considered self-employed.
The freelancer must maintain accurate records of calculating and paying their taxes. The critical aspect is planning for the tax season, knowing what taxes are to be paid, and filling in the appropriate forms. Awareness on deductions and planning enables these individuals to pay fewer freelancer taxes and have better income.
Although the responsibility around freelance taxes rests mainly with the individual, there are several freelance tax forms that, as an employer, you need to be aware of and share with your freelancer within specific cut-off dates.
What do You Need to Know about Freelance Tax Forms?
Freelance tax documents will change with each country. If you are looking to hire a freelancer based in the U.S, the applicable tax forms they need to submit are as follows:
The first of the freelance tax form, the W-9, governed by the Department of the Treasury Internal Revenue Service, is essentially a form that precedes all other tax forms. This document is a way to get the freelancer’s name, address, and Social Security number. In itself, you need not submit the Form W-9 directly to the IRS, but it is a must-have prerequisite so that you can complete other freelance tax documents.
Freelancers outside the U.S must fill and submit W-8 BEN or W-8 BEN-E to the employer instead of a W-9. This tax form proves that the freelancer you are onboarding is not a U.S citizen and performs work from outside the United States. The additional aspect to duly note is that depending on whether the freelancer is an individual or an entity. There are two different W-8 forms.
Miscellaneous Income tax form: FORM 1099-MISC must be filled out for every freelancer you have paid during the year. It is an important form that helps freelancers calculate their tax liability arising out of income received via freelancing assignments.
For any payments that are upward of $600 and made via a third party settlement entity, known as a payment settlement entity or PSE, FORM 1099-K is required to be sent by you to the freelancer. This freelance tax form ensures a record of a reportable payable transaction and is important in the necessary list of freelance tax documents.
Additionally, Freelancers also have an option to distribute their tax liability over four quarters that are estimated. For that purpose, FORM 1040-ES is filled out by the individual for making the payments against freelancer tax. However, this form is optional, and freelancers can also pay the quarterly estimated taxes directly on the IRS Website.
Typically, estimated tax is the method used to pay tax on income that isn’t subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony, etc.), which is very typical of freelancer taxes.
Taxes Applicable for Freelancers
Freelancer taxes are regulated across three jurisdictions: federal, state, or local level.
This is likely to be the most significant tax slice for freelancers as they typically get taxed under two heads.
- Income Tax: Income taxes are progressive, which means if they earn more, they pay more. Typically the tax percentage varies from 10% to 37% (as of 2021, for the U.S).
- Self-Employment Tax: This tax comprises Social Security, and Medicare contributions. Freelancers pay for both parts. However, another tax break for freelancers comes from the fact that when freelancers file their tax returns, they get to claim the employer’s portion as a deduction.
Additionally, state or municipality taxes may apply depending on the state. Usually, the freelancers check the state and local regulations for applicable freelance taxes. The IRS state government website can prove to be a good starting point.
Several local bodies might impose freelance taxes, depending on the city, county, or jurisdiction in which they operate. Components such as annual or one-time business registration fees may be charged in a few localities. The local chamber of commerce in these places usually provides the requisite details.
State-level laws might also impose additional sales tax over the freelancer tax. In this case, it is critical for the individual first to fill out an application for a state sales tax permit to avoid penalties.
What is interesting to know is that even in this category, there are tax breaks for freelancers if:
- They run a freelancing business based in Alaska, Delaware, Montana, New Hampshire, and Oregon.
- The nature of their freelancing business is only to provide services and not selling of goods and products (except in the states of Hawaii, New Mexico, South Dakota, and West Virginia).
How do Freelancers File Their Taxes?
If you are wondering, with so many complications around, how do freelancers file their taxes?
Here are the steps involved in filing taxes.
Step 1: Determining earnings
The first step in determining whether the freelancer taxes are applicable is to arrive at a value representing income (expenses minus the earnings). Being a sole owner, aspects of self-employment tax, which covers medical and social security taxes, are also included.
Step 2: Being aware of the tax deductions
Next, it is essential to understand what deductions the freelancers are eligible for when paying taxes. This helps calculate the final earnings for which a freelancer must pay taxes. To substantiate these deductions, freelancers must maintain a digital record of these expenses.
Step 3: File the taxes quarterly
In countries like the United States, when net earnings are over $400, freelancers must start paying quarterly taxes, or else it is subject to a penalty. Generally, freelancers seek the assistance of a qualified accountant who can help with accurate figures. There are important cut-off payment dates for filing quarterly taxes, and hence as an employer, it is critical that you also provide the freelancer with the required tax forms. We have covered this in detail in the next section.
Here are the quarterly filing cut-off dates:
- Income earned from January 1 through March 31 – April 15
- Income earned April 1 through May 31 – June 15
- Income earned June 1 through August 31 – September 15
- Income earned September 1 through December 31 – January 15
Step 4: Mode of Payment
There are multiple payment modes available to pay freelancer taxes. Online payment continues to be a more convenient option, but payments are made offline, too (through physical forms).
While most freelancers are sole owners or proprietors and individually pay freelance taxes, there is an option to register the freelancing business as an LLC and claim further tax deductions. This is called the S Corp form of taxation.
In doing so, taxes are reduced as the Federal and self-employment tax categories are not applicable. This process involves additional steps:
- The freelancer must pay themselves a monthly salary and file two tax returns – as an individual and for the S Corp
- Have a scalable business model, including the hiring of staff
- Make a revenue of roughly 80000$ a year
What are Freelance Tax Deductions?
Like any mode of self-employment, freelancers are eligible for tax deductions.
As a freelancer, one may work from a home. Freelancers can write off these expenses of working from home. However, freelancers must guarantee that the expenses are solely for business purposes are show proof that validates the same.
To maintain a functioning home-office space, one needs utilities like electricity, internet connections, air conditioning, etc. If freelancers can efficiently calculate costs, they are also eligible for this deduction.
Maintaining the business
Freelancers are also eligible for deductions if they use a personal laptop, pens, paper, printing cartridges, stapler, other stationery, etc. If it is relevant to the business, one can get a deduction for using a video camera.
Depreciation of business assets
Equipment and business assets bought as part of freelancing assignments can be written off as depreciation spread over the years of use—usually, a professional tax assists with ascertaining the proper values.
Travel and Meals
As freelancers, even travels and entertainment about client visits and engagements are eligible for tax deductions across flights, stay, and meals during trips. Freelancers could also seek deductions for dry cleaning and laundry in some cases.
Just word of mouth isn’t enough for running a successful freelancing business. While digital channels are inexpensive, traditional channels are premium and expensive. Freelancer tax deductions enable them to also claim for these expenses.
Protect self and assets
Deductions for freelancers allow them to claim insurance premiums. It helps cover malpractice arising from business conduct or insurance to protect the individual’s life.
Expense to upskill and research material
Sustaining a freelance business is challenging. Freelancers need to stay aware of trends and keep upskilling themselves. The state allows freelancers to seek tax deductions for any expense incurred to upskill.
Setting up a business
To set up a business, freelancers incur some initial expenses. The freelancer tax deductions provide for a write-off for these expenses as well.
Multiplier: Your Reliable Partner for Onboarding Freelancers
Hiring globally can present several challenges for the company. These challenges include but are not limited to time zone differences, language barriers, lack of regulatory knowledge, expensive setup, etc.
At Multiplier, we become the bridge to address these gaps. Through a SaaS-based solution, we enable employers to hire and manage diverse talent worldwide. These solutions cut down your expenses as you don’t need to partner with several local partners or set up a new entity by aiming for a seamless onboarding experience.
With our Employer on Record solutions, we act as a primary employer. You can offer all benefits like employee insurance, ESOP, payroll, etc. We are more compliant and well-versed in local labor laws. Our solutions are scalable, enabling you to hire multiple individuals, and the technology used is proprietary.
Frequently Asked Questions
Q. Do freelancers pay less tax?
Freelancers are entitled to more deductions as compared to an employee. They are also eligible to claim deductions for self-employment tax.
Q. When I onboard freelancers, do I have any obligations as an organization?
Yes, some tax forms depending on the region/ country, must be shared with the Freelancer so they can file their taxes promptly.
Q. Do I need to hire a professional to help with my freelancer tax?
It is always beneficial to have a CA/CPA help calculate the freelancer’s taxable income. The deciding factor in hiring a bookkeeper or CA/CPA largely depends on the budget. However, all your needs will be taken care of by Multiplier should you choose to take our services.