I love being self-employed as a freelancer. I can work from anywhere, and I have a lot of freedom and flexibility in my schedule. However, one of the things that took some getting used to was the taxes.
When you work for someone else in a more traditional job, your employer pays part of your payroll taxes. When you’re self-employed, though, you pay both sides of the payroll tax, increasing the burden on you. You can offset a portion of these self-employment taxes with the help of a tax deduction, but it still often means paying more than you feel comfortable with.
Another consideration is the fact that when you’re self-employed you don’t have your employer withholding taxes from your paycheck. You have to remember to pay your taxes on a quarterly basis, and it feels more painful because someone else isn’t taking care of it for you.
You can make paying taxes more manageable as a self-employed person, however. Over the years, I’ve developed a system that helps me more effectively pay my taxes without running into huge problems.
Create a High-Yield Account for Your Tax Money
Every month, I automatically transfer money from my checking account into a high-yield savings account designed to hold my tax money. You are supposed to pay your federal taxes quarterly when self-employed, so when my quarterly taxes are due I transfer the required money into my business checking account and write a check.
When using this method, don’t forget about state taxes. In the past, I’ve forgotten to account for state taxes, and been unpleasantly surprised. Figure out your federal and state taxes based on last year’s bill, and divide that amount by 12. Each month, make your payments so that you aren’t scrambling when taxes are due. Plus, it’s a way to break your tax bill down into smaller chunks.
Find a Way to Prepare for a Higher Bill
Most years, I make more money than I did the year before. This means I usually owe money come April. However, as long as I pay 100% of what I owed the previous year, I can avoid penalties for underpaying.
I do try to prepare for the possibility of a higher tax bill. When I was married, we compensated by boosting the amount of money withheld from my then-husband’s paycheck. Now that I’m divorced, I’ve changed things up a little bit. Now I add a couple hundred dollars a month to my “withholding” from my account. I let the extra money sit in the high-yield account and earn interest until it’s needed to pay my tax bill.
Breaking down a potentially higher bill into monthly chunks can keep it manageable and help you avoid an unaffordable bill later.
Of course, if you do end up in a situation where you owe more than you expected, and you can’t make immediate payment, the IRS does offer payment options to help you get back on track. If you do end up taking advantage of these payment options, you will need to make further adjustments to ensure that you remain on top of your coming tax payments, as well as playing catch up. Once you fall behind, it can be difficult to stay on top of your taxes going forward, so review your finances and your situation, and do your best to keep it manageable overall, including getting help from professionals if you need it.