The Tax and Bookkeeping Challenges of the Freelancing cover

The Tax and Bookkeeping Challenges of the Freelancing

  • Learn about self-employment taxes.
  • Discover how freelancers can easily fall behind on their taxes.
  • Learn why bookkeeping is so important when calculating deductions.
  • Find out why freelancers should seriously consider hiring a pro to help them with bookkeeping and taxes.

If it seems like more and more employees are turning to freelance work these days, you're not imagining things. According to one recent study, there are currently 73.3 million freelancers in the United States alone. The fast-paced mobile era that we're now living in, coupled with the advent of the fabled "Gig Economy" and companies like Uber and Lyft, have certainly helped bring this about. But what is fascinating isn't necessarily how many freelance workers there are – it's who, exactly, is doing the freelancing.

The tax and bookkeeping challenges of freelancing

Another study indicated that Generation Z seems particularly fascinated by the idea of striking out on their own. According to the study, 53% of them have chosen self-employment of this nature in most cases. Approximately 50% of all Generation Z respondents to one survey (meaning those who fall between the ages of 18 and 22) engaged in freelancing of some kind.

It makes sense that people want more control over their own employment and ability to earn a living. That doesn't mean it is easier than "traditional employment," however. This is especially true when it comes to the financial side of the equation. Bookkeeping and especially taxes present significant challenges that people need to understand before choosing to freelance.

The Financial Side of Freelancing: An Overview

Self-employment taxes

One of the biggest challenges that freelance workers face has to do with the idea of paying self-employment taxes.

Not only is it easy to suddenly find yourself working a freelance job – it can also happen very quickly. People often make the decision without taking the time to research the long-term implications. One of the most pressing of those is self-employment taxes. In addition to the income tax you’ll owe, you'll owe an additional 15.3% on the first $160,200 of net profits.

This money is designed to cover Social Security and Medicare taxes – factors usually handled by a traditional employer, with the payroll taxes split between the employer and employee. In a freelance situation, that burden falls entirely on you. If you don’t know that you have to pay this amount, or if you cannot accurately estimate this amount given your income, it could end in a significantly larger tax bill than you had assumed you would face.

Many new freelancers are surprised to find out that they're supposed to pay taxes throughout the year. Indeed, quarterly estimated tax payments are mandatory. If you don't handle this, you could accrue penalties before you even file your taxes.

Falling behind on your taxes

If you receive a large tax bill at the end of the year because you haven’t paid quarterly, you could always ask for a monthly payment plan with the IRS to settle your balance. Note, however, that this does not mean that your next round of estimated tax payments won't immediately come due. This is a situation where it’s easy to fall behind on your taxes. With penalties and interest, you could watch that "Past Due Balance" grow and grow. Even though things will be "fine" from a certain perspective so long as you keep up with your agreed-upon monthly payments, it could still be difficult to "get ahead" once again.

Deductions and bookkeeping

For many freelance employees, figuring out what deductions they're allowed to take given their job is not just a tax challenge – it's a general bookkeeping one as well. This will largely depend on what type of freelancing you're doing. If you're working for a company like Lyft or Uber, for example, you should be tracking the miles you drive while you're "on the clock”. You may be able to deduct a portion of not only your gas but also your maintenance and insurance costs based on that information if you choose to claim actual expenses rather than a business mileage deduction. But you can only do so if you've been tracking your business mileage accurately all along.

Typically, expenses fall into two distinct categories. "Ordinary" expenses are those that are common and that are traditionally accepted for your business. "Necessary" expenses, on the other hand, are those that are deemed "necessary" for your business.

The aforementioned business mileage while working for a ride-sharing company would be a common expense, for example. The same is true of any dues that you have to pay to even take the job, or subscriptions that are being paid out to organizations related to your business. Necessary expenses would be certain tools and other pieces of equipment that you cannot perform your job without.

Some of these challenges are the reason why, according to another recent study, 70% of people see freelancing as a viable career option when it exists alongside a traditional 9 to 5 job. Having a traditional employer handle at least some of the tax burden in a way that makes things easier overall can work out well. That doesn't mean you can get away with not thinking about bookkeeping and taxes at all, however, as the universal challenges outlined above go a long way towards proving.

Get a pro

If nothing else, all of this serves as an important reminder of why people need to enlist the help of an experienced professional to handle bookkeeping, tax, and related challenges. It's clear that the instinct to "do it all themselves" is a strong one for many people. If it weren't, they wouldn't be so passionate about freelance work in the first place.

But this is one of those situations where it is extraordinarily easy to "get things wrong" and if you do, you could wind up in a financial situation that is difficult to recover from. Enlisting the help of a professional can help prevent these problems from happening early on, allowing you to enjoy all the benefits of freelancing with as few of the potential downsides as possible.

Need advice on your freelance situation? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.

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