How to Pay Taxes as a Freelancer in 2023
April may be considered tax season for most people, but for freelancers, taxes are a year-round reality.
To help keep your finances organized and avoid costly surprises at the end of the year, we talked to Angie Moody, the founder and CEO of Ruby Money, to get her best tax tips for freelancers.
Below, Moody shares how freelance taxes are different from the traditional W-2, how to pay taxes as a freelancer, and the best practices that freelancers can follow throughout the year to keep their finances organized.
How to Pay Taxes as a Freelancer
Before we dive into the best practices for managing your taxes throughout the year, it’s important to understand why and how taxes are different for freelancers and self-employed people.
The Difference Between W-2 and 1099
Think back to when you were an employee. You had a W-2 and your employer took care of taxes. Typically, a certain percentage of your income was automatically pulled out of your paycheck every two weeks. By the time you receive your paycheck, you don’t even see the money that was set aside for taxes.
The process is much more complex for freelancers and requires planning way ahead of tax season. As a freelancer, you don’t get a W-2. Instead, you’re responsible for everything — tracking and reporting all of your income, budgeting for taxes, calculating deductions, and submitting 1099s from your clients. You’re also responsible for figuring out how much you need to pay in taxes. This can all come as a surprise when tax day rolls around if you weren’t aware of all of the requirements and didn’t keep track of everything throughout the year. Moody had a similar tax experience as an independent consultant, which ultimately fueled the inspiration behind Ruby Money, her mobile app for freelancers.
“I hadn't really tracked anything separately and I didn’t know about any of the different deductions [because] I hadn’t thought of myself as a small business owner,” recalls Moody. “Fast forward [to tax season], and I had a big surprise tax bill that I hadn't budgeted for.” She also adds that not knowing about certain tax deductions that freelancers can take added to the confusion. “I found out after the fact that [I paid] about $12K more than I should have because I just made stupid mistakes.”
Moody’s experience is not uncommon for freelancers navigating self-employment taxes for the first time. But fortunately, there are several ways to make this process more manageable — and even save yourself time and money — and it starts with quarterly taxes.
What are Quarterly Taxes?
Quarterly taxes, or estimated tax payments, are payments made to the IRS on specific dates for each quarter. Anyone who is self-employed and anticipates owing at least $1,000 in taxes over the course of the year, must pay estimated taxes each quarter. If you don’t make your quarterly estimated payments, you can incur penalties from the IRS (more on that later).
The idea of having to pay taxes four times a year instead of just once may seem baffling or even unfair if you’re new to freelancing. After all, a freelancer’s income fluctuates and it can be hard to predict what you’re going to make next month, let alone next quarter — especially if you’re just getting started.
But quarterly payments are actually meant to make it easier for freelancers and self-employed people to pay their taxes. By paying in small increments throughout the year, rather than shelling out one large payment at the end of the year, you can avoid a costly and unexpected tax bill that you may or may not have budgeted for.
6 Tax Tips and Best Practices for Freelancers
To keep your cash flow strong and prevent surprise tax bills, freelancers have to stay on top of their taxes all year long.
Follow these tax best practices throughout the year so you can spend less time worrying about the IRS and more time working on the parts of your business that you enjoy.
1. Create a separate bank account
One of the easiest ways to set yourself up for success when it comes to taxes is to create a separate bank account for your freelance business. Keeping your business transactions and personal ones separate makes tracking expenses and deductions easier, whether you or an accountant is handling your taxes.
“It doesn't have to be a business bank account and it doesn't have to be fancy, it just has to be a separate bank account” says Moody. “Because then you know that all the money that gets spent out of that account is for your business and you don't miss any of those business expenses.”
2. Track your business deductions
There are a ton of tax deductions you can claim as a freelancer. The IRS recognizes that running a business comes with expenses and, as a result, allows you to take deductions that can reduce the amount you pay in taxes.
“Most deductions are actually expenses you spend on your business, like your computer or your software subscriptions,” says Moody. “Those are really important to keep track of because you get 30% of [deductions] back in the form of a tax refund.”
To get the most out of your deductions and ensure you aren’t leaving money on the table, track all of your spending and expenses from day one (having a business bank account makes this easier, as we mentioned above).
“It’s important to get a really good sense of what your business deductions are throughout the year,” recommends Moody. “Don't wait until the year is done and it's February and you're running around with spreadsheets and credit card statements trying to figure out what you spent.”
3. Make your tax rate part of your business strategy
If you’re wondering how much to put away for taxes, start with knowing the tax rate. The self-employment tax rate is 15.3%. This covers Social Security and Medicare taxes, which are typically covered by your employer when you have a W-2 job. But as a freelancer, you are both the employee and the employer, so this responsibility falls solely on you. In the US, your taxes will also include a federal income tax and potentially a state income tax depending on where you live, so the general rule of thumb is to set aside 30% for taxes.
“If you are a professional freelancer offering a creative service or knowledge service, taxes are your number one expense, aside from hiring other contractors,” says Moody. “Taxes are literally going to be 25-45% of your income, so recognize that as part of your business strategy. How do you tackle that? How do you create a cash flow plan and how do you create a strategy to lower that?”
Getting clear on your tax rate and implementing it into your business decisions can help inform your pricing, your budget, and your savings. Once you know how much of your money is going to taxes, you can raise your rates to factor these taxes in and ensure you’re earning enough to cover all of your expenses and savings.
4. Budget for taxes (and automate the process)
When you pay your quarterly estimated taxes, they’re exactly that: an estimate. You’re making these payments based on what your expected income for the year will be. As a freelancer, you may have an idea of what your total yearly income will be, but it’s also hard to guarantee it like you can with an employee salary. That’s why it’s important to budget enough for taxes throughout the year, even if that means overpaying your quarterly taxes. If you overpay your estimated tax payments, you will get that money back as a tax refund. If you underpaid, you will owe money at the end of the year.
Moody recommends creating that safety net for yourself by recreating the experience of having a W2. This means automatically setting aside a portion of your net pay for your taxes. You can use a tool like Ruby Money to automate this for you, or you can manually commit to setting aside a specific amount of each paycheck. No matter how you choose to do it, automating this aspect makes it easy for you to budget and set aside enough for taxes without being tempted to spend those payments elsewhere.
5. Avoid tax penalties
If you don’t pay your quarterly estimated taxes, you can incur penalties from the IRS. These fees depend on the amount you owe in taxes, but they can make a significant dent in your earnings or savings, especially if you didn’t expect or plan for them.
There may be some cases where it makes sense to hold onto your money throughout the year instead of paying estimated quarterly taxes. Maybe you’d rather have more cash flow and take the fee that comes along when you pay your taxes in full on tax day.
However, Moody advises against this. “It’s a dangerous, slippery slope to be on unless you have a really complex and stable understanding of your finances and you have professionals advising you to do that,” she says. “The safer way is to just follow the recommendations and make those quarterly estimated payments.”
6. Save for retirement
Yes, it is more than possible for freelancers to make a stable income, set aside money for taxes, and *still* have money left over to put into retirement savings. It requires a bit of planning, but with the right tool or process, it can be a seamless part of your financial plan.
“The best hack that I like sharing with self-employed people is tax-free retirement and what I call a profit shelter,” shares Moody. “It is a loophole that the IRS has created specifically for self-employed people to say, ‘I'm going to give you the ability to stash 25% of your profits away from the IRS. We won't see them, we won't tax them.’”
She adds, “The trick is [the money] has to go into a special account called an IRA, an individual retirement account. And if you're self-employed, there's a bonus account called a SEP-IRA which allows you to contribute up to 25% of your profits as a solopreneur.”
Here’s a quick example Moody shared: Let’s say you make $100,000 and want to put 10% of your profit into an IRA account. You live in a medium-high tax rate state like New York and your tax rate is 35%. $3,500 of that $10,000 that you put away immediately comes off of your taxes. So your tax bill just dropped $3,500, but you didn’t actually spend the money. Moody calls this “paying future you”.
“When you talk to small business owners and really big business owners, this is one of the top wealth creation strategies,” says Moody. “And I think freelancers think, ‘Oh, it's not for me’ or ‘I'm not wealthy enough,’ but even if you're only setting aside $100 every paycheck or a couple hundred every month, rather than putting that in a brokerage account, just be boring and put it in an IRA because the money works double for you. It lowers your taxes and it earns interest over time.”
Navigating freelance taxes isn’t always easy, but it’s more than manageable when you have the knowledge and tools at your disposal. Don’t wait until tax season to figure out your freelance tax plan — follow these best practices throughout the year to build a solid foundation for your business.
Angie Moody is the founder and CEO of Ruby Money, a mobile app to help freelancers earn more and avoid costly tax mistakes. Ruby Money tracks self-employment income, helps you save for quarterly taxes, and automatically pays those taxes. Since its founding in 2021, Ruby Money has raised over $2 million in funding and launched its flagship app in the App Store.
Watch the full conversation with Angie during her episode of The Leap here. And follow Wethos on Instagram to catch more episodes of The Leap, an Instagram Live series where we have insightful conversations on all things freelancing with people who have taken the leap themselves.