Freelance work - Charging for tax?

[lielec11]

Good morning all,

I recently started doing some freelance work in the engineering services field. My work is starting to pick up where I am beginning to worry about how my income taxes will be effected at the end of the year. If I receive 1099's from all the company's I am working for, should I be marking up my fees for taxes up front so I can set that money aside to pay taxes next April? It seems there are different ways to tax (sales tax for physical good and products vs. use tax for services) for good/services. And if my research is correct the self employment tax rate is about 15.3%. Any input is greatly appreciated.

I live in NY for reference.

Thank you.

[I'm a red panda]

When I freelance, I make sure that my compensation is higher than if I was doing salaried work because my tax rate is higher.  But I don't ever make a line item for "tax".

You need to look into tax laws- you likely need to be paying quarterly estimates. There is a fine if you do not do this.

[GizmoTX]

Definitely increase your billing rate to cover federal self employment taxes, & make estimated payments quarterly or risk a penalty.

Also, your state may require sales tax on your services, so you need to check this too. In this case, you would list sales tax as a separate line item, report & pay it quarterly. You would need a state tax ID number.

[Retire-Canada]

I'm in Canada. I do consulting work and I charge federal Goods and Services Tax [GST] on each invoice [5%] as a specific line item. What I do is exempt Provincial sales tax [7%] or I would charge that as well as a second line item.

I keep a running total of my collected GST which gets submitted quarterly.

I also submit my income tax quarterly based on an estimate for the year.

You definitely want to keep track of all your taxes owing and understand the schedule for remittance to the Gov't.

-- Vik

[Selene]

I've been freelancing for a while and definitely charge enough to take into account taxes but I don't put a line item for taxes on my invoices. My accountant did suggest I make quarterly payments and since my freelance income is so uneven (I work full-time as a software engineer so the freelance income isn't my main source), she told me I could just shoot her an email with my earnings so far for the year and she would tell me what I should pay each quarter. It's worked out well so far. You may not want to pay for an accountant but after I ended up owing over $1,000 my first year of freelancing, it's worth my peace of mind to make sure I get the taxes right.

[Syonyk]

Save about 35-40% of your 1099 income for taxes. The self employment tax is on top of your normal tax rate.

[terran]

I'm pretty sure you'd be laughed at if you asked your clients to pay the tax, just like if you asked an employer to pay your income taxes. It's an expected part of making money. That said, you absolutely should charge more as a freelancer than you would get as an employee to make up for the extra taxes. You should also be charging more to make up for the lack of other benefits (health insurance, retirement matches, whatever other perks you might otherwise get), and for times you will go without work (you won't get unemployment benefits remember).

I save 50% of my freelance income in an account dedicated to cover the tax bill, but this usually leaves me with extra to fund an iRA/etc too, so you might be fine with saving a third depending on your tax bracket. Since this is your first year you can skip paying quarterly taxes an just pay a big bill next year, but in following years you'll have to pay quarterly taxes either based on the previous year's tax due, or on ongoing calculations you make throughout the year based on actual earnings.

[lielec11]

Thanks all for your input.

@Syonyk, that is ugly so basically you're losing out on almost (or more) than 50% of your freelance income to taxes - that's absurd.

I already pay to get my taxes done so that isn't an issue. The tough part about this is negotiating a fee as clients tend to be very tight and will move on to the next person if you ask for more. So it is a very hard balance between getting a fee that's worth your time and keeping the clients happy. I will say this, freelancing is great but it also tends to water down the industry as the fees are much lower than a full size firm would charge, at least in my industry.

[lielec11]

I'm pretty sure you'd be laughed at if you asked your clients to pay the tax, just like if you asked an employer to pay your income taxes. It's an expected part of making money. That said, you absolutely should charge more as a freelancer than you would get as an employee to make up for the extra taxes. You should also be charging more to make up for the lack of other benefits (health insurance, retirement matches, whatever other perks you might otherwise get), and for times you will go without work (you won't get unemployment benefits remember).

I save 50% of my freelance income in an account dedicated to cover the tax bill, but this usually leaves me with extra to fund an iRA/etc too, so you might be fine with saving a third depending on your tax bracket. Since this is your first year you can skip paying quarterly taxes an just pay a big bill next year, but in following years you'll have to pay quarterly taxes either based on the previous year's tax due, or on ongoing calculations you make throughout the year based on actual earnings.

@terran - I actually did claim some income on my last years return (about 2k-3k), so does this mean I need to start paying quarterly this year?

[GizmoTX]

You need to do an estimated tax calculation now & send your first quarterly payment by April 15. The estimate & quarterly payments can vary during the year. Not paying anything exposes you to penalty/interest for that quarter.

[MDM]

I actually did claim some income on my last years return (about 2k-3k), so does this mean I need to start paying quarterly this year?

Not if you can (and do) adjust withholding from your day job to cover the taxes that will be due from the side job.

[GizmoTX]

True; additional withholding also works.

[Syonyk]

@Syonyk, that is ugly so basically you're losing out on almost (or more) than 50% of your freelance income to taxes - that's absurd.

Yeah, the taxes on profits are high.  On the other hand, I can deduct a chunk of my house (the home office space), any driving/travel I do (at $0.54/mile or whatever the current rate is), hardware I purchase primarily for work purposes (phones, laptops, servers, etc), my internet connection, a chunk of my cell phone bill, etc.  So I can eliminate a good chunk of profit before I ever see that tax rate.

Also, my hourly bill rate for freelance stuff is almost 2x what I make (hourly, assuming standard work weeks, etc, etc) at my (very comfortably paid) day job.  The only reason it's so low is because I'm doing work for people I've been working with for a long while.  And I can do the work where I want, when I want, as long as it gets done.  I actually miss my pure freelance days (and will be back there at some point in the next few years), because there's nothing like being able to say, "Damn.  It's a beautiful afternoon out.  I don't have anything immediately due.  Screw it, I'm going biking."  And then spend a few hours bicycling around in 75 degrees and sun.

The tough part about this is negotiating a fee as clients tend to be very tight and will move on to the next person if you ask for more. So it is a very hard balance between getting a fee that's worth your time and keeping the clients happy. I will say this, freelancing is great but it also tends to water down the industry as the fees are much lower than a full size firm would charge, at least in my industry.

Ah.  Not sure what industry you're in, but I've generally found that getting in a race to the bottom isn't worth it.  If someone wants to play that game with me, I suddenly don't have time for their project anymore.  I have plenty of work (if I want it) that pays me well and is interesting, and my clients are happy with the work I do, because I'm the "coder of last resort."  They know that for pretty much any weird thing that other people can't figure out, I'll be able to solve it.  So they just throw me the weird stuff. :)

My life doing freelance work got a lot happier when I realized that I can set my rates or quotes however I want.  If a particular customer is a royal pain to deal with, I start quoting them a lot higher.  Either they pay me more, which compensates for the fact that they're difficult, or they find someone else to do the work, so I don't have to deal with them.  On the other hand, if you don't pay your invoices promptly, I will fire a customer or refuse to work for them unless paid up front.

[lielec11]

I actually did claim some income on my last years return (about 2k-3k), so does this mean I need to start paying quarterly this year?

Not if you can (and do) adjust withholding from your day job to cover the taxes that will be due from the side job.

I'll check my ADP account and see if I can vary this additional withholding throughout the year, thanks.

[Syonyk]

I'll check my ADP account and see if I can vary this additional withholding throughout the year, thanks.

If you're doing reasonable amounts of freelance work, setting zero deductions and a bit extra per paycheck is usually enough to get you close.

[lielec11]

Yeah, the taxes on profits are high.  On the other hand, I can deduct a chunk of my house (the home office space), any driving/travel I do (at $0.54/mile or whatever the current rate is), hardware I purchase primarily for work purposes (phones, laptops, servers, etc), my internet connection, a chunk of my cell phone bill, etc.  So I can eliminate a good chunk of profit before I ever see that tax rate.

Also, my hourly bill rate for freelance stuff is almost 2x what I make (hourly, assuming standard work weeks, etc, etc) at my (very comfortably paid) day job.  The only reason it's so low is because I'm doing work for people I've been working with for a long while.  And I can do the work where I want, when I want, as long as it gets done.  I actually miss my pure freelance days (and will be back there at some point in the next few years), because there's nothing like being able to say, "Damn.  It's a beautiful afternoon out.  I don't have anything immediately due.  Screw it, I'm going biking."  And then spend a few hours bicycling around in 75 degrees and sun.

I deduct my phone bill and some other home office items for my day job, I'm assuming it's one or the other and I cannot double dip?

Ah.  Not sure what industry you're in, but I've generally found that getting in a race to the bottom isn't worth it.  If someone wants to play that game with me, I suddenly don't have time for their project anymore.  I have plenty of work (if I want it) that pays me well and is interesting, and my clients are happy with the work I do, because I'm the "coder of last resort."  They know that for pretty much any weird thing that other people can't figure out, I'll be able to solve it.  So they just throw me the weird stuff. :)

My life doing freelance work got a lot happier when I realized that I can set my rates or quotes however I want.  If a particular customer is a royal pain to deal with, I start quoting them a lot higher.  Either they pay me more, which compensates for the fact that they're difficult, or they find someone else to do the work, so I don't have to deal with them.  On the other hand, if you don't pay your invoices promptly, I will fire a customer or refuse to work for them unless paid up front.

I'm in the consulting engineering industry (i.e. construction). I do agree that a race to the bottom is not worth it. I'm just starting this so I'd like to build up some clientele but I also don't want to work for scraps.

If you're doing reasonable amounts of freelance work, setting zero deductions and a bit extra per paycheck is usually enough to get you close.

I set 0 on both state and federal. I'm in the 28% bracket.

[MDM]

I'll check my ADP account and see if I can vary this additional withholding throughout the year, thanks.

You should be able to submit a new W-4 at any time, even multiple times, during the year.

The nice thing about withholding is that you can withhold in December (for example) and that amount is treated as having been withheld throughout the year. 

E.g., see http://taxes.about.com/od/paymentoptions/a/estimated_tax_4.htm and/or http://www.irs.gov/publications/p505/.

[Syonyk]

I deduct my phone bill and some other home office items for my day job, I'm assuming it's one or the other and I cannot double dip?

I'm not a tax lawyer, but I'd be pretty confident in saying, "No, you cannot double dip for tax deductions."  The IRS has no sense of humor at all.

I'm in the consulting engineering industry (i.e. construction). I do agree that a race to the bottom is not worth it. I'm just starting this so I'd like to build up some clientele but I also don't want to work for scraps.

Do good work, and make it known to happy customers that you're taking on work, if their friends need anything done.  Happy customers make great advertising.

[MDM]

I set 0 on both state and federal. I'm in the 28% bracket.

That may or may not be appropriate, depending on the amount of non-W2 income.

See http://forum.mrmoneymustache.com/ask-a-mustachian/how-can-we-optimize-our-withholdings/ for more details.