Tax savings for the self-employed
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Raise your hand if you’d rather host a luncheon with Pennywise the clown than deal with your self-employed taxes. *All freelancers raise hands*
Not only are taxes super stressful, but they’re also way more terrifying than a sketchy clown hanging out inside of a sewer. With taxes, you don’t know what you don’t know, which means you could be making mistakes without even realizing it. And, those mistakes could cost you money.
But before you panic, know that most self-employed tax mistakes are easy to avoid. The first step? Identifying your errors, so you can fix them.
To help you, we’ve put together a list of the top five tax mistakes businesses-of-one make and how to avoid them.
Not knowing your tax deductions
Some tax deductions are pretty obvious, like writing off your business website or marketing expenses. But where self-employed folks go wrong is sticking to Captain Obvious deductions, instead of venturing out into the big wide world of write-offs.
When you only write off the small handful of deductions that you know, you miss out on other tax write-off opportunities. And you miss out on lowering your tax bill.
A quick refresher: As a self-employed person, you’re taxed on your taxable profit, or your gross income minus your tax deductions. So, more tax deductions translate to less taxable income. And the less your taxable income, the less you pay in taxes.
Most small-business owners are shocked when they learn there are more tax deductions than advertising, meals, and travel expenses. And, that by not taking other deductions, they’re missing out on a lot of tax savings.
Am I suggesting that you write off everything from your vintage Tamagotchi to your best friend’s bachelorette party? No, of course not. But I am suggesting that you get clear about what you can and can’t write off. Don’t assume that something you haven’t written off before isn’t a legit deduction.
So, how do you know what you can write off? You can start by checking out this list, then reach out to an accountant or tax preparer. Just a one-hour consultation with them about your deductions could save you some serious money in the long run.
Also good to know: Collective users receive unlimited support from their personal bookkeeping and tax team. You can send them your tax deduction questions year-round and they’ll give you personalized advice.
Using your personal account to pay for business expenses
Just like Fight Club, bookkeeping has rules. And the No. 1 rule of bookkeeping is never to use your personal account for business expenses.
Why? Because you’ll miss you out on significant tax deductions, which we just learned are essential to lowering your tax bill.
Oh, sure, you think you’ll go back through your personal statements at the end of the year and tally up those expenses. But if you’re a procrastinator like me and do your taxes days before the deadline, there’s no way you’re dealing with that.
That adds up to a whole lot of missed deductions.
The good news? Avoiding this mistake is really easy. Just make sure you pay for all your business expenses from a business checking or business credit card account. And if you slip up, because we all do, enter the expenses into your bookkeeping program immediately.
Skipping the home office deduction because you’re afraid of an audit
First, what actually counts as a home office for tax purposes?
The IRS defines a home office as a space that’s used regularly and exclusively for business. “Regularly” means you can’t use it once a year and call it a home office. You must use it consistently.
“Exclusively” means there’s a clear delineation between your home office and your personal living area. Couches, dining room tables, and your bed don’t count as exclusive because they also have a personal purpose.
If you’ve gotten this far and thought, “OK, so I shouldn’t write off my couch as a home office?” then yes, you’re correct and you can skip ahead. But if you do have a legitimate home office, keep reading.
The home office deduction adds up to some major tax savings. The way it works is that you get to write off a percentage of your total home expenses. These include:
- Utilities such as gas, electric, water, and garbage
- A security system
- Homeowners or renters insurance
- Homeowners association fees
- House cleaning
- Repairs made to your entire home
To figure out the deductible percentage, divide the square footage of your home office by the square footage of your entire home.
So, if your home is 1,500 square feet and your home office is 300 square feet, you would write off 20% of your home expenses.
Let’s say your monthly home expenses are $3,000, which is $36,000 per year. If you wrote off 20% of those costs as home office expenses, it would come out to a $7,200 deduction.
Mic drop. You may be thinking, “But, won’t this deduction trigger an audit?”
While this used to be the case, many financial professionals believe that’s no longer true. More importantly, if you have a legitimate home office, then it’s your legal right to deduct it. The IRS doesn’t just come up with a list of deductions to trick business owners into getting audited. It sets rules and guidelines based on what it thinks is fair.
So, if you have a legal home office and you’ve been too scared to claim it, start deducting it now.
Blowing off your estimated taxes
If you’re self-employed, you’ve probably heard of estimated taxes. You may have even had the best intentions to pay them and then you didn’t. You know, cash flow gets tight. Clients pay you late. You absolutely need that life-size replica of Captain Kirk’s chair for your office.
Here’s the deal: If you’re self-employed and expect to owe at least $1,000 in taxes for the year, then you’re required to pay estimated taxes. Also known as quarterly taxes, these are prepayments toward your final tax bill, which you receive when you file your annual tax return.
Estimated tax payments are due:
- April 15
- June 15
- September 15
- January 15
If any of these dates fall on a weekend or holiday, then payments are due the next business day.
Why should you pay these on time? Because if you don’t, you get hit with an underpayment penalty, which you’ll pay in addition to your final tax bill. The penalty amount depends on how many days late you pay, so the longer you wait, the higher the penalty.
To avoid paying the penalty, you can do one of two things:
- Pay at least 90% of your current year’s tax liability (split this into four payments and make each payment by the due date).
- Pay 100% of the previous year’s tax liability (split this into four payments and make each payment by the due date).
To be honest, unless you love math and tax tables, it’s easier to pay 100% of the previous year’s tax liability.
Projecting your current year’s tax liability means math, math, and more math. And, you’ll have to adjust your calculations if you have a sudden influx of income. Using the previous year method, you already have the numbers; it’s just a matter of making the payments.
In either case, make it a habit to set aside money for your taxes every month and pay your estimated taxes every quarter.
Not updating your tax strategy
Many self-employed people think they have to stick with the same tax strategy forever. But, smart tax planning for a new business owner is very different from smart tax planning for an established, high-earning business.
And by sticking with your original tax strategy, you could be paying way more in taxes than you need to.
If you’ve been in business for several years and your numbers are steadily increasing, it’s time to reassess how you approach your taxes. There may be changes that could save you thousands of dollars in taxes.
Tax strategy is definitely get-professional-help territory. Talk to a tax expert about your business, and let them crunch the numbers to figure out what’s best for you. You can also use our tax savings calculator to see what potential tax savings await you.
And that’s it! Even fixing just one of these mistakes could amount to some big tax savings. And who knows, you may become so confident with your taxes that you’re willing to brave Pennywise’s sewers alone… or not.
Andi Smiles, small business financial consultant and coach, teaches rad business owners to take control of their finances so they can step into their personal power.
She’s helped hundreds of self-employed folx organize and understand their business finances, while also uncovering their emotional relationship with money. Andi’s core belief is that when business owners are engaged with their finances, their personal awareness around money deepens, creating more sustainable and authentic businesses. She loves helping business owners connect with and feel good about their finances- no matter how many dollars are in their bank account.