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How to keep up with your taxes as a freelancer to 'minimize pain and surprise,' according to CFPs

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Key Points
  • Almost two-thirds, 63%, of independent contractors are concerned they'll owe more taxes than anticipated, according to a new survey.
  • If you owed more in taxes than you thought you would, take steps now so you're not in same position next year.
  • "Chip away at your tax liability throughout the year, so at the end of the year, you can minimize pain or surprise," one expert says.

If you're earning so-called 1099 income as an independent contractor, entrepreneur, or side hustler, tax season can induce a special kind of anxiety.

At the heart of the issue: Unlike W-2 employees, taxes are not automatically deducted from freelancers' paychecks. So the onus is on you to figure out how to manage your business tax obligations, which may include paying quarterly estimated taxes and tracking potential deductions.

It can be tricky, which is why 63% of independent contractors are concerned they'll owe more taxes than they thought, according to a survey by the Independent Economy Council.

Planning ahead can help curb some of that anxiety, says Kevin Mahoney, a certified financial planner and founder of Illumint in Washington, D.C. "Chip away at your tax liability throughout the year, so at the end of the year, you can minimize pain or surprise," he says.

Here are some steps you can take now for a smoother tax filing next year.

VIDEO3:1603:16
How to pay taxes as a freelancer

Video by David Fang

Make a tax projection

The first thing you can do is make a tax projection, says Mark La Spisa, a CFP and president of Vermillion Financial in Barrington, Illinois. That estimates what your tax situation could look like for the year, based on details including projected income and potential deductions. You can hire a professional to do this, or most tax software can create one for you, he says.

There are also some general rules you can follow that will give you a ballpark estimate. For example, if you earned $200,000 in gross income this year and paid $40,000 in taxes, that's 20% of your income. Knowing that can inform how much of each paycheck you set aside to meet tax obligations.

"I would use last year's numbers to put you into a good percentage versus pulling a number out of the sky," La Spisa says.

Put some money away when you can

Almost half, 47%, of freelancers aren't setting aside income every month for their taxes, according to the Independent Economy Council survey. This, experts say, is a mistake.

You'll typically need to pay quarterly taxes to cover the tax obligations from your 1099 income. You can estimate those each quarter, or use the so-called "safe harbor rule" to avoid underpayment penalties, LaSpisa says. Under that guideline, if your adjusted gross income was under $150,000 last year, you can make quarterly estimated payments totaling 100% of last year's tax or 90% of what you expect to owe this year, whichever is smaller. If you earned more than $150,000, your quarterly estimated payments must total 110% of last year's tax.

If you're an independent contractor, your income might not be consistent, so be sure to put more away when you have an especially high earning period, Mahoney says.

"When the funds are available, make an estimated payment or set aside that money in cash — which is not going to be touched until that time comes and you know what your taxes are going to look like," he says.

When the funds are available, make an estimated payment or set aside that money in cash.
Kevin Mahoney
CFP

It's okay to dip into your emergency savings

When Tax Day comes, if you owe a bit more than you thought, it's okay to dip into your emergency savings account, Mahoney says.

"The tax bill may not be something you necessarily saw coming, but if you've saved that cash and have it available for whatever purpose, a good use of that is helping with this," he says.

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