Everything You Need to Know Before Quitting Your Job to Go Freelance

·6 min read

There are many different reasons why someone might consider making the switch from full-time employer to freelancer. Freelancing can give you the flexibility to create your own schedule, the opportunity to earn more money once you're self-employed, and the independence to work on multiple projects, just to name a few.

According to Wingspan, a company that provides freelancers with a range of resources in one place (think invoicing, benefits, and bookkeeping), 68 percent of freelancers say their life has improved since making the transition to freelance. So, it should come as no surprise that freelancers will account for the majority of the American workforce by 2027.

While becoming a freelancer has its perks, there are many factors to think about before leaving your full-time job behind. From healthcare to taxes and beyond, here is everything you should know about before handing in your two weeks' notice.

Paying income taxes as a freelancer

Due to the unusual pandemic circumstances, the IRS did extend the tax returns deadline for 1040 forms, which may include a W-2, to May 17 this year. But freelancers (who don't have a W-2 form) are generally required to file quarterly taxes, which were first due on April 15. Subsequently, they'll file forms due on June 15, September 15, and January 15 of the following year. Freelancers also submit an annual tax return with their reported income, which includes 1099-MISC forms from every client who paid them $600 or more attached to a form called Schedule C.

"Unlike full-time employees, your income won't be withheld for taxes. As a freelancer, you will be required to estimate your annual earnings and pay your taxes quarterly," Jacob Dayan, CEO and Co-founder of Community Tax and Finance Pal explains. "If you estimate too little, you may be subject to a tax penalty on Tax Day. If you estimate too much, you will receive the excess in your tax refund, but overpaying can leave you short on cash. On or before the quarterly deadline, you can pay your estimated taxes on the IRS website, using form 1040-ES."

Freelancers should begin to pay quarterly taxes if they expect to owe more than $1,000 on the tax deadline. It'll help to have a separate business account to streamline your expenses and income.

But what, exactly, do freelancers owe in estimated taxes?

For starters, it depends which state you live in. This is why it's best to speak to your local accountant. However, all freelancers have to pay a federal income tax, which is something employees pay, too. The only difference is, companies withhold that tax from their employees' paycheck and freelancers have to withhold it themselves.

But freelancers also have to pay what's called the self-employment tax—a tax consisting of Social Security and Medicare taxes, which withholds 15.3 percent of the first $142,800 of income you receive, plus 2.9 percent of anything you earn over this amount.

Companies will pay for half of the SE tax, leaving employees to pay about 7.5 percent of their income. Most accountants suggest to set aside between 25-35 percent of your taxable freelance income to cover your estimated taxes.

Even though it seems like freelancers owe more taxes than salaried employees, freelancers are able to claim much more in tax deductions, which can level out the cost of SE taxes.

What can freelancers deduct from their business expenses?

Freelancers can deduct a wide variety of business expenses, including their home office (AKA part of your rent), entertainment subscriptions, car maintenance, utilities, trips, 50 percent of meal expenses, phone bills, health insurance, and much more.

"Consult with a professional accountant to find out just how much you can deduct. On the bright side, the visit will also count as a tax deduction," Jim Pendergast, SVP of Small Business Financial Institution, explains.

How can freelancers find affordable individualized healthcare?

Once you leave your job, you'll be legally covered by your company's health insurance under COBRA. But, your company won't be subsidizing it anymore and it can be really expensive. If you don't have a partner who can add you to their health insurance plan, there are a few options to explore.

"Finding affordable healthcare is one of the biggest challenges of freelancing. There is no one-size-fits-all solution to this," Charlotte Robinson, a freelance software engineer and programmer, explains. "So, I recommend freelancers choose from the following options based on what suits them the best: coverage under the Affordable Care Act, choosing short-term health insurance, or association-based insurance plans if your profession has any such guild/association." Health insurance plans also depend on where you live — some states have more affordable options than others.

"The Health Care Exchange in your state can connect you to private plans that are right for your situation. You can work with a healthcare broker too to get the best plan for your family," Jess O'Connell, an editor and entrepreneur, explains.

Do freelancers need to incorporate their businesses?

Freelancers aren't required to incorporate their businesses as an LLC. But those who do incorporate as an LLC use it to protect their personal assets and gain credibility. In some states, however, an LLC may save you on taxes depending on your income. According to Investopedia, those who have an LLC can choose to be taxed as S-Corps or C-Corps, which may benefit some businesses by reducing their employment taxes.

"My accountant mentioned it was time to consider looking into other tax options that could potentially save money in the long run. We decided that operating as an LLC taxed as an S-Corp would be the best option because it provided me with some protection and had greater tax benefits than continuing to operate as a sole proprietor," Toni Okamoto, the founder of Plant-Based on a Budget, explains. As with your taxes, you should consult with an accountant about which business type is right for you.

How do client contracts work?

Freelancers should send their clients a contract before they begin working together—detailing project scope, rates, deadlines, revisions, and anything else you want to include. You don't need a lawyer to oversee your contract, but you'll likely need a lawyer to draft the contract for you. Or, you can purchase a contract from another freelancer. Freelance writer Kat Boogaard, for example, sells customizable contract templates drafted by an experienced attorney. Plus, the templates include a companion guide that breaks down the legal jargon into plain English.

How can freelancers save for retirement?

Through a SEP IRA plan, (Simplified Employee Pension Individual Retirement Account), freelancers can make contributions that may potentially be tax-deductible. You won't have an employer matching your retirement savings, but at least you can save some money every year. The Self-Employed 401(k) is another option where you can choose to make a tax-deductible or Roth contribution of up to 100% of your compensation.

Becoming a freelancer can seem complex, since so many crucial systems would otherwise be taken care of by HR and your employer.

"All of these things can seem overwhelming or complicated at first, but when you familiarize yourself with the process, you'll find it's just a different way of doing things—and can provide many benefits for you and your family to go freelance," O'Connell says.

Once you gather the resources available to you, and consult with other freelancers and experts (again: hire an accountant!), you'll start reaping the benefits of #TFreelanceLife.