How the taxes differ
An employer withholds tax from each paycheck and pays half of your Social Security and Medicare contributions. When you work for yourself, nobody withholds anything and you pay both halves. That is the self-employment tax, 15.3 percent of net earnings, owed in addition to income tax. You must file a return if your net self-employment earnings reach $400 for the year, and all of the income is taxable whether or not a client ever sends you a 1099 form. Profit and loss are reported on Schedule C of your federal return, and half of the self-employment tax is deductible.
Pay during the year
The IRS expects tax as income is earned. If you will owe a meaningful amount, you make quarterly estimated payments, due in April, June, September and January, using Form 1040-ES or the IRS online payment system. Skipping them brings an underpayment penalty on top of the bill. If you also hold a regular job, an alternative is to raise the withholding on that paycheck with a new Form W-4 to cover the side income. Many states expect estimated payments as well.
Keep the money separate
Open a second checking account and run all freelance income and expenses through it. Legitimate deductions reduce both taxes: software, equipment, supplies, professional fees, business mileage and a home office used regularly and exclusively for the work. Keep receipts and a mileage log, since a deduction without a record does not survive an audit. You do not need an LLC to begin, though your city or state may require a business license, so check with the local clerk's office.
Price and paper
A common shortcut for an hourly rate is to take the annual salary you would want for the work and divide by 1,000. The arithmetic assumes that about half of your hours are billable and that you cover your own insurance, taxes and time off. Put every job in writing, even a one-page agreement, and include the following.
- The agreement states the scope of the work and the number of revisions included.
- The agreement states the fee, the deposit and the payment terms, such as net 15 or net 30.
- The agreement states a late fee and what is owed if the client cancels.
- The agreement states who owns the finished work.
Invoice promptly and follow up the day a payment is late.
Note Read your employment agreement before taking side work. Many contain moonlighting or invention-assignment clauses, and using your employer's laptop or hours can hand them a claim on the result.
