Should You Add Tax to Your Freelance Project Invoices?
If you’re asking this question, chances are you’ve been unhappily surprised at how much you owe in taxes around April 15th.
In fact, this article was inspired by a Reddit user who asked, “I’m tired of getting stiffed at tax time. Can I add tax to my invoices? If so, how much tax should I add?”
Tell me if this sounds familiar:
You didn’t realize that, unlike a normal paycheck, taxes aren’t taken out automatically when your clients or customers pay you. You didn’t think to save money for taxes throughout the year and now suddenly have a heavy tax burden. Now you’re wondering if you should add taxes to your invoices and pass your tax burden onto your clients.
If that’s not the case, maybe you’re just wondering if you’re missing something because it’s an option in your invoicing software:
The short answer is: it depends. But let’s dig deeper.
You’ll always pay taxes
First, let’s establish that it’s impossible to completely pass your tax burden onto your clients. That’s because taxes are a percentage of your income and invoices and sales tax is much different than income tax.
So if you owed 35% in income tax, you can’t just add 35% sales tax to your invoices and have your clients pay the tax on your behalf. That’s simply not how taxes work.
In fact, this will have quite the opposite effect. You’ll earn more, but consequently pay more in taxes:
- If you charge $1,000 and owe 35% ($350) in taxes, your net income will be $650.
- If you charge $1,350, you’ll still owe 35% ($472.50) in taxes and your net income will be $877.50.
Insight: Gross income is your income before taxes and expenses. Net income is your income after taxes and expenses.
So there is no way to avoid taxes or even reduce your tax burden (or tax “liability”) by simply marking up your invoices.
In fact, if you apply tax to your invoices, but don’t specifically file sales tax at the end of the year, you haven’t actually charged that client a tax. You’ve just charged them more money and made it look like a tax, which means you’ll now be taxed on more income without passing any tax burden onto your clients.
The only way not to get “stiffed” at tax time is to be more prepared — and you can prepare by understanding your finances, staying disciplined, and saving for taxes throughout the year.
Should you charge sales tax?
So when should you add taxes to your invoices? In short, it depends on what the invoice represents. The general rule of thumb is that:
- If the invoice is for the sale of a product, you likely will need to apply sales tax.
- If the invoice is for the sale of a service, you likely won’t need to apply sales tax.
You might hear some people omit the word “sales”, which can be confusing and misleading:
👉 “Products are taxable, while services are non-taxable.”
That does not mean you’re exempt from paying income tax when you get paid for your services. It just means you don’t need to charge sales tax when you sell that service.
Again, these are two completely different types of taxes.
Note: Tax laws are complex and can vary by state, business type, product type, and service type. Always consult your accountant to answer financial questions about your business.
Most freelancers reading this blog offer digital services such as web design, development, photography, and marketing. If that’s you, you don’t need to apply sales tax to your invoices. It’s not necessary and might cause your clients to question why you’re charging them a tax when other service providers do not.
I’ve been designing websites as a freelancer for almost 15 years and I’ve never added tax to an invoice. No clients have ever asked why taxes weren’t included, and no accountant has ever advised me to include taxes on an invoice.
However, if you sell a product, you may need to charge a sales tax. This tax percentage would be equivalent to your state sales tax rate, NOT your income tax bracket percentage.
For example, if you sell a hand-made product in New York State, you can charge 8% sales tax on that item. You’ll then need to file sales tax at the end of the year. You cannot charge a 35% tax just because you fall into the 35% income tax bracket.
As always, I highly recommend you consult an accountant to make sure you understand how sales tax works and when you need to apply it to your sales.
Forming a Company
Some of you more savvy readers might be thinking, “can I save on taxes by forming a company?”
I wrote a detailed article about why I chose to form an S-Corp instead of continuing to work as a 1099 contractor (the legal term for “freelancer”).Why I Switched from 1099 to S Corp (and How It Impacted My Freelance Business) Forming an S-Corp can offer massive tax savings, legal protection, and improved client perception for freelancers and independent contractors.
In short, you’re paying the highest taxes possible when you’re operating as a 1099 contractor, and forming a company definitely has the potential to save you money in taxes.
Many people are familiar with LLCs, which are inexpensive business entities to set up and operate. The downside is that there are no tax benefits whatsoever compared to operating as a 1099 contractor.
S-Corps are more expensive and complex to operate, but can potentially offer major tax savings. That tax savings can be yours if you’re able to earn more money than what the IRS considers a “reasonable salary” for your profession in your geographic location.
So, if $40k is a reasonable salary, but you’re earning $80k, you can pay yourself $10-20k in shareholder distributions which are NOT subject to the 15.3% self-employment tax that all freelancers pay.
If you find that you’re still not making enough money after paying taxes, then you need to charge more for your services or sell more of your products. While it’s not necessarily advisable to derive an hourly rate from your desired salary, it’s a good starting point.
Figure out how much money you need to take home each year (net income) to:
- Survive: the bare minimum you need to pay your bills ($35k)
- Live: the amount you need to live comfortably ($60k)
- Thrive: the amount you need to spend, save, and invest ($120k)
Then figure out how many projects or products you need to sell, and at what cost, to reach those numbers after taxes. For example, if you want to bring home $60k of net income as a 1099 contractor in the U.S., you probably need to earn close to $100k of gross income in most states. This assumes you’ll pay about 40% of your income in taxes.
For more tips on saving money and navigating taxes as a freelancer, check out these articles and the one below!Why I Switched from 1099 to S Corp (and How It Impacted My Freelance Business) Forming an S-Corp can offer massive tax savings, legal protection, and improved client perception for freelancers and independent contractors.