The basic equation for a Schedule C, or another other business-related tax return, is income minus expenses equals profit. If the profit figure is a positive number, congratulations! You are one of the few self-employed people who made money as a freelancer. If the profit figure is a negative number, you have a business loss. Join the crowd. The vast majority of freelancers incur losses. A business profit increases your taxable income, and increases both your regular income tax and your Self-Employment Tax. The Self-Employment Tax, figured on Form 1040 Schedule SE (PDF), is 15.3% of your net profit and represents the Social Security and Medicare taxes owed on your business profit. As an employee (on a W-2), you only pay half of the Social Security and Medicare taxes (7.65%), and your employer pays the other half. As a freelancer, you are your own employer, so you pay both halves.
Most self-employed people get into tax trouble because of the Self-Employment Tax. You need to set aside money at least every quarter, or better yet every month, towards your Self-Employment Tax. Let's say you anticipate having a net profit of around $1,000. Well, your Self-Employment Tax would be ($1,000 x 15.3%) $153. If you divide that into four quarterly payments, you should be paying $38.25 every quarter to the IRS as an estimated tax payment. You should also calculate your anticipated regular income tax. If you are in the 25% tax bracket, the additional income tax on your business profit would be ($1,000 x 25%) $250. So you should set aside $403 ($153 + $250) over the course of the year towards your estimated taxes. Freelancers who fail to make reasonable estimates of their future taxes often end up owing at the end of the year. Paying a balance due can be a hardship for struggling freelancers. Protect yourself from tax troubles by planning ahead, and making a sincere effort to pre-pay your taxes.
I recommend all self-employed entrepreneurs to enroll in EFTPS, the Electronic Federal Tax Payment System. Once you are enrolled, you can make estimated tax payments by phone or by Web, with the payment debited directly from your checking account. It's like bill pay for your taxes. The nice thing about EFTPS, you can schedule payments ahead of time, and you can designate exactly where you want each payment to go.
