The high cost of earning little?

March 14, 2009 10:41 PM

Am I really paying $1,000 in taxes to freelance?

I'm doing my taxes online, at FreeTaxUSA, which shows me a running total of my balance/refund as I submit new forms. My return contains two forms: a W2 from my main employer, and a 1099-MISC from an organization I've done some contract work for.

As I submitted the W2 and the 1099-MISC, and applied the standard deduction, my federal refund was ~$750 and my state (CA) was $150.

Finally, I was told by the site to attach the 1099-MISC to a Schedule C; most of which is blank, as I'm not a business owner. As soon as I did this, my federal refund became a friggin' $50 balance! My state refund dropped to $0!

My freelance work amounted to about $3,000 for a non-profit. Can this be correct? And does this mean I'm paying almost $1,000 for the "privilege" of doing freelance work?

posted by evil holiday magic to work & money (22 answers total)

Yeah, standard wages are taxed as you go. Contractors are paid directly (essentially business to business) so they are taxed quarterly or in your case yearly. So your paying a $1000 for the pleasure of doing business in the US as an individual citizen (isn't it great!).
posted by doctor_negative at 10:51 PM on March 14, 2009

Generally speaking in the US you pay about 25% of 1099 income back to the government, depending on your income level. This is because you're paying not only the taxes on it, but also yur own social security which your company pays if you are employed as a regular W-2 employee. There are things you can do to mitigate this. It's a good idea to read up on deductions, NOT just the standard deduction that you can take as a W-2 employee but also expenses you incurred in earning that $300 are often deductible [cost of postage, equipment, travel expenses to name a few] because for every dollar that you claim as a deduction from your Schedule C monies, that's a dollar less you have to pay taxes on. I'm oversimplifying but not much.

I AM NOT A TAX PERSON, but I've been doing my own taxes for decades and making at least some 1099 money most years [this year I had twelve 1099 forms in addition to four W-2 forms] and yes it's a pain but yes also it's a true statement. You wind up paying more in taxes because certain things are taken care of when you're a regular old employee that you then have to pay for on your own as a contractor. That said, there are things you can do when you're expecting it that can mitigate this an awful lot.
posted by jessamyn at 10:58 PM on March 14, 2009

Yeah, man. It's a big bite that Uncle wants.

I generally put away about 30-35% for taxes out of every payment I receive for any business I transact. It's a lot easier to take out your own withholdings as you go and never look at that money as income than it is to write out a check at the end of the year when you didn't expect it.
posted by Netzapper at 11:03 PM on March 14, 2009

Yeah, taxes ream you if you're freelance. Sorry. I lost about 25% of my money to taxes each year when I was freelance.
posted by The otter lady at 11:04 PM on March 14, 2009

As a freelancer you should put a standard (minimum) 25% of your incoming cash, regardless of gross or net, into a holding account for taxes.

Hopefully you can lock down a CD or high interest account to make a bit of coin off this cash (interest will also need to be taxed) before you fork it over to Uncle Sam.

Another way to not get such a big hit is:
If you are also working a "normal" job, maybe you should think about claiming "0" and putting a small amount per paycheck (line 6 on the current W4 form) over to the gov'ment.

Also be sure your taxes are being done properly and that you are claiming all expenses related to your freelancing business.
posted by crustix at 11:18 PM on March 14, 2009

I encourage you to go to the IRS site and grab a 1040 Schedule C (or C-EZ if you're not taking any deductions) and Schedule SE. Take a look through these, and the 1040 form, and learn how the paperwork and calculations work firsthand before taking the word of a TurboTax-a-like.

The federal tax rate for self-employment income (1099-MISC) is 15.3% (12.4% for social security, 2.9% for medicare). That's $459 of $3000, so there's a chance the website is calculating your taxes incorrectly.

These are rough calculations, and I don't know your exact situation. I'm not a tax preparer or accountant (for you or anyone).
posted by greenland at 11:18 PM on March 14, 2009

Yes. As a 1099 you paid ZERO in taxes. Taxes, including social security, state taxes, medicare, etc float around 20%. Maybe more depending on your state.

There's a chance that the software you are using saw the 1099 and then remove the standard deduction too. Consult a pro about this.
posted by damn dirty ape at 11:31 PM on March 14, 2009

Chiming in with greenland; go through the forms or have a pro look at it; yes, you pay a lot more taxes directly as a freelancer, and I had a similar reaction the first time I had enough freelance work to tax (on top of regular-job work), but $1k out of $3k sounds like a bit much. Give it another look.
posted by furiousthought at 11:45 PM on March 14, 2009

Picking up on crustix, another thing to consider is that you're just under the threshold where the IRS expects estimated payments this year from any similar amount of freelance income. It's a bit complicated, with a number of "safe harbor" guidelines that can spare you the underpayment penalty and the annoyance of quarterly payments, but it's not something to ignore until next spring.

So, yeah, it bites. If you get more freelance work, put away between a quarter and a third, depending on your expenses. And since you're filing a Sched C, you should be able to deduct the cost of a professional preparer or non-free web/desktop tax prep.
posted by holgate at 12:22 AM on March 15, 2009

No, you are being paid $3000 to freelance, of which you get to keep $2000.
posted by mmdei at 1:32 AM on March 15, 2009 [1 favorite]

And does this mean I'm paying almost $1,000 for the "privilege" of doing freelance work?

No, you're paying for the privilege of being a working American citizen.

Of course you're paying roughly that much (percentage-wise) on your day job as well, but your employer pays more than half of it for you, and you get the rest withheld from every check as you go so you don't feel it at the end of the year.

Look very closely at that Schedule C. Make sure you list any equipment you bought last year that you used to do your work, as well as any related fees, driving miles, meals, etc, etc. There are plenty of guides on the net with long lists of suggested deductions. I'd be surprised if you can't knock a couple hundred dollars off your final.

Oh, and FreeTaxUSA kinda stinks. You can try H&R Block and TurboTax online for free until you submit your return to compare and see if one gives you a better result.

This year, if you plan to continue with the freelance work pay your quarterlies or increase your withholding to compensate.
posted by Ookseer at 1:46 AM on March 15, 2009

Welcome to the world of self-employment. Taxes are just another expense you have to take into account when setting your hourly rates. If you needed to actually keep $3K to make the freelancing worthwhile then you should've charged $4200. If the nonprofit wouldn't have paid you that much for it, well, that's just one reason why being in business is harder than it looks.
posted by jon1270 at 3:54 AM on March 15, 2009

The reason you're paying so much here is that 1) taxes aren't withheld from freelance pay, and 2) you don't have an employer to pay their half of payroll taxes.

In normal employment, the employee pays about 6-ish% of income, which is matched by the employer, for Social Security, the Mediplans, unemployment, etc. You also pay income taxes.

In freelance situations, nothing is withheld, so come April 15, you're responsible for all of income tax, your payroll tax, and your employer's half of payroll tax.

Sucks, but that's just how it works.
posted by valkyryn at 4:26 AM on March 15, 2009

Other commenters are correct- you aren't taking a greater hit for working freelance, it just seems that way.

No taxes were withheld from your freelance work, whereas taxes are withheld from your regular job. This is compounded by the fact that the freelance work adds to the top line of your income, meaning it is taxed at the highest rate applicable to your situation.

You'd probably have the same results if you did an experiment and added $3000 to your regular income with the same dollar amounts for taxes paid.
posted by gjc at 8:37 AM on March 15, 2009

You do pay more taxes as a freelancer, because as others point out, you're paying more in Social Security and Medicare. Simply adding $3k to your W-2 income to check the tax increase wouldn't quite work, because it wouldn't increase your Social Security and Medicare payment the way 1099 income does.

It sounds like you need to track your freelance expenses as well as your income and include those expenses on Schedule C.
posted by PatoPata at 9:35 AM on March 15, 2009

Make sure the tax software is giving you a deduction for half the self-employment tax. The employer's portion of FICA and Medicare are considered business expenses and are tax-deductible. It is probably doing this correctly, but it wouldn't hurt to check.
posted by kindall at 9:39 AM on March 15, 2009

You may be interested in this recent question on taxes.
posted by odinsdream at 11:10 AM on March 15, 2009

Everybody is right. Over the last two years, I've worked solely freelance. During 2006 tax season last year, I was massacred -- even after a ridiculous amount of deductions (I'm a travel writer! I can deduct travel!) I still owed around $2500.

Like greenland said, this is because of the self-employment tax, which is 15.3% ABOVE the taxation rate for your actual income. You must pay SE tax and file Schedule SE (Form 1040) if your net earnings from self-employment were $400 or more. So even if you only made enough income to fit in the 15% bracket, you're still paying 30%. This is why we full-time freelancers deduct like crazy people.
posted by changeling at 11:14 AM on March 15, 2009 [1 favorite]

That sounds about right. Are you taking all the biz-related deductions you can? On Schedule C you have a much wider range of deductions than you do on Schedule A, and you'll save more in taxes by claiming them. (that was hugely oversimplified. IANAA.)
posted by nax at 11:24 AM on March 15, 2009

on preview, @changeling- lol. that describes me to a T
posted by nax at 11:25 AM on March 15, 2009

Actually, you're paying the exact same amount of taxes on your freelance income as you are on your W2 income, it's just that our stupid system of "employer pays half/employee pays half" disguises this when it comes to your W2 income. 15.3% of all of your income goes into social security and medicare. Contra greenland, the software probably is doing things right, since after the $459 of SE tax, the other three-four hundred was the actual income tax you owed.

One tip: If you plan on taking on more freelance work, you should consult a tax accountant because you may need to start paying in SE tax quarterly to avoid penalties from underpayment. Just like I have my taxes withheld throughout the year, so you, once your freelance income passes a certain threshold (which is unfortunately not constant), may need to start paying in quarterly.
posted by odragul at 12:17 PM on March 15, 2009

I don't have a W2, as a sole proprietor what ends up saving me is being able to deduct costs on the home office and computers and whatnot I've bought (I'm a web developer), along with mileage deductions from meeting clients. A normal person doing work on the side probably is going to have it pretty rough, especially since I think a lot of people don't come up with reasonable hourly wages for themselves.
posted by floam at 2:02 PM on March 15, 2009