What Freelancers and Side Giggers Need to Know About Income Taxes

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The freelance lifestyle has numerous advantages — among them, freedom and flexibility. Even so, you can't escape your tax obligation to Uncle Sam, and being a freelancer poses its own challenges at tax time. Consider these factors that might impact your income taxes: (See also: 8 Tax Return Mistakes Even Smart People Make)

1. Track All Forms 1099-MISC

Every client from whom you earn $600 or more in payments for services performed must file Form 1099-MISC, Miscellaneous Income with the IRS. Like employer-issued W-2s, every time that a client issues you a 1099-MISC, the IRS receives a notification. They're essential in order to prove your income, so make sure to keep track of all of them. Generally, form 1099-MISC needs to be issued by January 31st. If you haven't received your form by February 15, request a duplicate from your client for your own records.

2. Include Income From All Sources

While a client isn't obligated to file a 1099-MISC when their total payments in the same year to you are under $600, you're still responsible to report those payments as taxable income in your return. The IRS charges a 25% inaccuracy penalty on top of applicable taxes and interest for late payments, including income from all sources, even when not reported on a 1099-MISC.

(As a side note, we keep on specifically referring to a 1099-MISC by its full name because there are several types of 1099s, including 1099-DIV, 1099-G, 1099-H, and 1099-INT.)

3. Separate Individual and Business Finances

To help you track cash flows directly related to your business, open a separate business bank account and credit card. (See also: The 5 Best Credit Cards for Small Businesses)

The monthly statements of those business bank accounts and credit cards will allow you to reconcile your monthly income statement and will be very handy in case of an IRS audit. When shopping around for a business checking account, consider one that keeps copies of used checks. The reason is that bank statements and canceled checks are acceptable documents in case you receive a Form 4564, Information Document Request from the IRS.

4. Hire an Accountant if Using Schedule C

Schedule C from Form 1040 is one the most useful tax forms for freelancers and side giggers because it allows them to deduct all applicable business expenses, ranging from cost of promotion in local media to use of home space for business purposes. (See also: 101 Tax Deductions for Bloggers and Freelancers)

However, individuals using Schedule C often make mistakes on this form. Whether those errors are intentional or unintentional, the IRS has noticed the higher number of mistakes and has set the policy of auditing individuals using Schedule C three times more often than it does corporations. Hire an accountant to file your taxes and they will make sure to cross your t's and dot your i's throughout your return, including the pesky Schedule C. Not to mention, their fee is an eligible expense on your Schedule C, too!

5. Calculate Your Withholding

Unless you're a full-time freelancer, keeping track of your estimated tax liability can be hard. When you're receiving income from both an employer and portfolio clients, you'll have more sources of income. In that case, the IRS Withholding Calculator is a useful tool to avoid having too much or too little federal income tax withheld throughout the year.

Analyzing data from your most recent pay stubs, invoices from your clients, and copies of past tax returns (they will help you estimate applicable deductions), this calculator will provide you suggestions on how to update your Form W-4 with your employer. Adjusting your W-4 throughout the year is a smart way to increase the take-home portion of paychecks from your employer when you're withholding more than you really need to.

6. Make Estimated Tax Payments

Due to the nature of freelancing, you may receive some last minute assignments that will make your bank account happy in the short term. Prevent those lucky breaks from turning into an unexpected large tax liability by the time you file your return next year. Whenever you expect a very large payment or an end-of-year assignment, use the IRS Withholding Calculator to estimate your necessary withholding.

An alternative to adjusting your W-4 is to make a lump-sum payment using Form 1040-ES, Estimated Tax for Individuals, which allows you to pay estimated tax payments on April, June, and September of the current year and January of the next year. Form 1040-ES can be a lifesaver to compensate for extreme low withholding throughout the year. For example, you can submit a payment for tax year 2016 on January 17, 2017.

7. Don't Forget About State Income Tax

On top of federal income taxes, you're also liable for applicable state and local income taxes. Depending on the legal structure of your business, you may file business income taxes on a separate form. Sole proprietors report their personal and business income taxes on the same form.

Spreading out your state tax liability is a better idea than trying to come up with a large lump sum in very few days. If you have an employer, you can also adjust your withholding of state taxes throughout the year. Most states allow freelancers and side giggers to submit estimated state tax payments on a quarterly basis. To learn more about your applicable state tax obligations, find the appropriate office in your state or territory.

8. Get Health Coverage

Under the Affordable Care Act (ACA), better known as Obamacare, you're subject to a penalty when you go more than two months without health coverage. In 2016 and 2017, the penalty fee is 1/12 per month of 2.5% of your household income or $695 per adult, whichever is higher. If you didn't meet the minimum essential coverage during 2016, use the IRS tool to estimate your individual responsibility payment.

When you're a full-time freelancer, you're responsible for getting qualifying coverage on your own. January 31, 2017 is the last day to enroll or change a 2017 health plan. After that date, you can enroll or change plans only if you qualify for a special enrollment period. To learn more about available plans in your ZIP code, visit the health insurance marketplace at HealthCare.gov.

9. Save for Retirement

Freelancers and side giggers with no employees can open a solo 401K to build or give their nest eggs a major boost. With a solo or Roth 401K, an independent contractor could save up to $53,000 ($59,000 if age 50 or over) in 2016 and $54,000 ($69,000 if age 50 or over) in 2017. By the way, married couples and legal partners receiving income from the same business practice can double those contribution limits. This means a couple under age 50 could potentially contribute up to $108,000 to a solo 401K in 2017!

If you're one of the estimated 54 million of U.S. independent workers or freelancers, consider a solo 401K to lower your taxable income and get closer to the target amount of your retirement fund.