As the gig economy expands, an increasing number of people are going independent or working as freelancers. While they have the autonomy and flexibility to work how they see fit, this also comes with an additional burden: they must pay taxes in a manner that differs from that of a conventional W-2 employee. We will go through the main distinctions between self-employment taxes and W-2 employee taxes in this article, as well as how freelancers can maximize their tax savings and file their taxes without any fuss.
Let’s start with the self-employment tax, which represents the biggest distinction between taxes for W-2 employees and taxes for self-employed people. Self-employed individuals are liable for both the employer and employee shares of social security and Medicare taxes, as opposed to W-2 employees who divide these taxes with their employer. The sum of these taxes is known as the self-employment tax, and it is determined using the company’s net income (profit).
The self-employment tax rate is 15.3% for the year 2021, which comprises 12.4% for social security and 2.9% for Medicare. The good news is that only net income that exceeds a specified amount is subject to this tax. The cutoff is $400 for the next year, 2021. According to the IRS, You are therefore exempt from paying self-employment tax if your net income is under $400.
Paying taxes as a freelancer
Understanding that you are a business owner and that there are tax repercussions as a freelancer is essential. You must accurately disclose your income, outgoings, and tax deductions in addition to paying your taxes on time. Establishing a distinct company bank account and keeping track of all your transactions there is one approach to streamline this procedure. Your tax filing procedure will be easier to manage if you keep your personal and company costs apart and use a quarterly tax calculator.
Paid Taxes in Estimate
Self-employed people must pay estimated taxes throughout the year in order to avoid fines for underpayment. Unlike W-2 employees, who have their taxes taken care of by their employer, freelancers are responsible for calculating and paying their own taxes. Your business’s net income and the anticipated tax rate for the year are used to determine the projected tax payment. The due dates for these quarterly payments are April 15, June 15, September 15, and January 15 of the succeeding year.
Being able to deduct specific business expenses from your taxable income is one of the most important benefits of being self-employed. These deductions might lower your tax obligation and hence improve your tax savings. Home office costs, travel costs related to business, advertising costs, and other costs associated with the creation of goods or services are a few popular deductions for freelancers.
To substantiate your deductions, you must maintain accurate records and receipts for all business costs. These costs can be subtracted from your net income at the end of the year, which will reduce your taxable income.
The manner in which taxes are withheld also distinguishes self-employment taxes from W-2 employee taxes. Employers withhold taxes from W-2 employees’ paychecks, thus these individuals get paid after taxes have been taken out. Self-employed people, however, must set aside a percentage of their earnings for taxes because no taxes are deducted from their income. This can be achieved by setting up a separate tax account and depositing a portion of your income there each time you receive payment.
As you can see, there are important distinctions between W-2 employee taxes and self-employment taxes. Self-employed people are required to pay self-employment tax, make anticipated tax payments, and maintain accurate records of their deductions. Furthermore, in order to avoid penalties, you must set aside a portion of your income for taxes and make timely payments. Freelancers can optimize their tax savings and reduce any unneeded stress during tax season by being aware of these distinctions and taking the appropriate action.