You’re a freelancer, getting stuff done, capturing new leads, and even finding time to post the occasional selfie on Instagram. You’re totally focused on growing your business when—bam!—it’s tax season.
You don’t even have time to respond to client emails, and now you also have to do your taxes. That’s seriously the last thing you want on your plate.
It’s the worst. Managing your own freelance business and getting all of your tax paperwork together is rough- we’ve been there.
That’s why we’re going to show you how to take advantage of the best possible tax savings for your business. Just doing our part to make tax season suck a little less.
Below, we walk you through everything you need to gather to properly file your taxes. Plus we’ve included some handy tips that you can implement to take advantage of the deductions that are worth using.
Work your way through the basic stuff first. Then dive into the more complex tax talk, which also includes simplified steps, tips, and resources to help you breeze through it all and get the most out of your tax return.
Please note that, while we’ve made every effort to ensure the following information is up-to-date and accurate, it doesn’t constitute, or serve as a substitute for, legal or tax advice. Consult with an attorney or tax pro for personalized guidance when you need it for your business.
Let’s start by covering the basic tax stuff you need to take care of:
Gather Records of Your Income and Expenses
First, you’ll need to gather all of your records to show your business income and expenses. Without these, you can’t complete your tax return. And the IRS already has copies of some of these records.
These are records that show how much money you earned. They include all Forms 1099-MISC that were sent to you by your clients.
These forms display the total amount that you were paid during the year, and you might have several 1099s if you worked with multiple clients.
Copies of every 1099-MISC are sent to you and the IRS, as well as your state tax department. This means that you must report every penny of income that’s listed on your 1099s. Failing to do so will be caught by IRS computers and result in questions. You definitely don’t want that!
Note: Clients must send you a 1099-MISC if they paid you $600 or more during the year by cash, check, or direct deposit. You should receive all of your 1099s by January 31, but some clients end up sending them late.
If clients pay you electronically via third party payment processors like PayPal, Square, or Stripe, they don’t have to file a 1099-MISC, but the payment processor might have to file a 1099-K to report the payments to the IRS.
This only happens if you’ve been paid more than $20,000 during the year via the processor, and you also have more than 200 transactions with that processor. If a 1099-K isn’t issued, the IRS won’t receive any record of the payments.
Whether or not a payment you received is reported to the IRS by the payer, you’re supposed to report it yourself on your tax return. Now, does everyone do this in real life? No, of course not.
But real talk- nobody wants to underreport their income and get audited. Not only would that be a giant PITA, but you’d also pay penalties and interest on back taxes.
The bottom line- just follow the rules and report your income.
You can deduct most of your business expenses from your business income. But you need to have some type of record to back up your expenses.
Receipts are required for expenses over $75. Other records you may use include canceled checks, bank statements, credit card statements, and electronic funds transfer records.
If you claim a deduction for business driving, you should have a mileage log.
Claim Common Tax Deductions for Freelancers
The key to lowering your taxes as a freelancer is taking advantage of all of the deductions that you’re entitled to.
Depending on your income, every dollar in deductions saves you up to 37 cents in federal tax. Hey, it adds up! Plus, you’ll save on state income taxes too.
Don’t forget that deductions also help you save money when it comes to paying your self-employment taxes (Social Security and Medicare), which are 15.3% of your profits.
Here are the most common deductions for freelancers:
The cost of all the driving that you do for business, with the important exception of commuting, is tax-deductible.
Uh, what’s commuting?
Nondeductible commuting is when you drive from your home to a place of business. For example, driving from your home to meet with a client would be nondeductible commuting. However, if you have a home office, you can convert such trips into deductible business trips (more on that below).
There are two ways to calculate your business mileage deduction:
First, with the standard mileage rate, you deduct a specific amount of every business mile you drove.
In 2019, the rate is 58 cents per mile. If you want to use the standard mileage rate, you must do so the first year you use your car for business. After that, you can switch to the actual expense method.
With the actual expense method, you deduct the actual expenses that you incurred whenever you drove for business throughout the year. These include the cost of:
- License and registration fees
- Other car-related expenses
You can even get a deduction for depreciation, which can be as much as $18,000 the first year if you use your car 100% for business (the exact amount depends on the cost of your car).
With either method, you need to keep track of how many miles you drive for business during the year, and also track your total annual mileage (business and personal combined). You can do this with a mileage tracker app like Mile IQ. If you didn’t do this last year, you might be able to reconstruct your business mileage by using your business calendar and calculating the mileage through Google Maps.
The amount of money that you spend on your business office is deductible.
For example, you might deduct the cost of rent and utilities to keep your office running.
You can deduct your expenses when you go out of town for business. Examples include the cost of airfare or other transportation, as well as lodging expenses, such as the cost of your hotel stay.
You can only deduct 50% of the cost of meals when you travel for business.
The days of the deductible 3-martini lunch are pretty much over. But the good news is that you may deduct 50% of the cost of business-related meals.
You or an employee needs to be present at the meal in order for you to be able to take this deduction.
The meal must be with a current or potential customers, consultants, clients, or similar business contacts, and you must pay for the meal in full, in order for it to count as a deduction.
The IRS doesn’t require that you actually close a deal or get some other specific business benefit if you want to take this deduction. So, you can deduct 50% of the cost of taking a prospective client to lunch, but it isn’t necessary that you discuss business at lunch.
Whenever you buy property for your business that will last more than one year, you can deduct the cost.
Due to recent changes in tax law, you can usually deduct the full cost in a single year. From 2018 through 2022, you can use 100% bonus depreciation to deduct in one year the full cost of the personal property you use in your business, such as computers.
This property can also be deducted in a single year using Section 179 expensing and the $2,500 de minimis deduction.
These deductions may be used for tangible personal property and computer software, but not real property, which must be depreciated over many years.
What are supplies, exactly? Well, they’re business items that you use up in less than a year.
Examples include everything from paperclips to postage stamps.
Legal and Professional Services
You can deduct fees that you pay to accountants, attorneys, consultants, and other professionals if the fees are paid for work that’s related to your business.
Insurance that you purchase just for your business is a deductible expense. For example, business liability insurance, or insurance for business property, would fall under this category.
If you have a home office, you may deduct a portion of your homeowner’s insurance. Sweet!
Advertising and Promotional Expenses
Just about all of the money that you spend in order to promote yourself and your business is considered a deductible business expense. This includes:
- the cost of designing and maintaining a website
- Internet hosting fees
- The cost of obtaining a domain name for your business website
- The cost of having brochures printed.
You can even deduct expenses like the cost of listings in professional directories, and the cost of having your resume worked on by a pro.
You can’t deduct the education expenses that you incur in an effort to qualify for a new business or profession. However, you can deduct education expenses if they’re related to your current business, trade, or occupation.
The expense must be used to maintain or improve skills that are required in your present business.
For example, a real estate broker could deduct the cost of real estate continuing education courses or the cost of a webinar on how to use social media to find sales leads.
Here’s some great news: self-employed freelancers can deduct 100% of their health insurance premiums, including dental and long-term care coverage, for themselves, their spouses, and their dependents. Woohoo!
This isn’t a business deduction. Instead, it’s a special personal deduction for the self-employed.
This deduction only applies to your federal, state, and local income taxes, not to your self-employment taxes.
Oh, and it’s limited to the net profit you earn from your business. If your business earns no money or incurs a loss, you don’t get a deduction.
To qualify for this deduction, you must not be eligible to participate in a health insurance plan maintained by your employer or your spouse’s employer.
Pro tip: If you aren’t taking all or most of these deductions, something may be wrong with your recordkeeping or your tax preparation process, and experts like those at Collective can help you get back on track.
Complex Tax Saving Strategies
Okay, here are some more complicated tax deductions that you might be able to take when you file your freelancer tax return.
Home Office Deduction
Do you use a home office exclusively for your business? Then you can deduct, as a business expense, a portion of the cost of running your home office.
For example, if you use 10% of your home as an office, you could deduct 10% of the cost of your home mortgage, rent, home utilities, and maintenance.
If you’re a homeowner, you also get a depreciation deduction.
And if you have a home office, you can even deduct driving that you do from home for business purposes, such as when you visit clients.
While all of this sounds straightforward enough, this deduction can be complex. To qualify for it, you must meet any one of the following requirements:
- Your home office is your principal place of business, meaning it’s where you do all or most of your work.
- You regularly and exclusively use your home office for administrative or management activities for your business and have no other fixed location where you perform such activities.
- You meet clients or customers at home.
- You use a separate structure on your property exclusively for business purposes.
- You store inventory or product samples at home.
- You run a daycare center at home.
Put simply, you must set aside a portion of your home to use just for your home office. It doesn’t have to be a whole room either.
You also need to keep good records of your home expenses, allocate the expenses of operating your home between business and personal uses, and complete a special tax form, Form 8829.
Retirement Account Contributions
One of the best ways to save on taxes is by establishing and funding retirement accounts.
Why bother with a retirement account, other than the peace of mind of knowing you’ll have money when you’re ready to retire? Because you can deduct your contributions up to annual limits, and you don’t have to pay any tax on investment earnings from retirement accounts until you withdraw the funds (note: early withdrawals before age 59½ are subject to a 10% penalty).
Several types of retirement accounts are available to freelancers, such as the Traditional IRA, Individual 401(k), and Simplified Employee Pension (SEP) IRA. Let’s break these down, shall we?
A Traditional IRA can be established by any individual, and you can contribute up to $5,500 and deduct the full amount if you and your spouse have no other workplace retirement plan.
An Individual 401(k) is an account that’s ideal for most freelancers because you can contribute a lot to it. For example, in 2019 you can contribute 20% of your net profit from self-employment, plus an elective deferral contribution of up to $18,500. The max contribution for 2019 is $56,000.
A Simplified Employee Pension (SEP) IRA lets you contribute up to 20% of your net profit from self-employment every year as well, and the maximum amount for 2019 is also $56,000.
If you’re 50 or over, you can make additional tax-deductible catch-up contributions to these retirement accounts. For IRAs, you can put in an additional $1,000. For 401(k)s, you can put in an additional $6,000.
You can establish and fund an IRA or SEP-IRA by the due date of your return and take a tax deduction for the prior tax year. So, you have until April 15 if you file your taxes by that date. If you file an extension, you have until October 15 to establish and contribute to your IRA.
A 401(k), however, must have been established by December 31 to take a deduction for that tax year.
The Tax Cuts and Jobs Act created a new tax deduction for individuals who earn income through pass-through businesses. This would include freelancers operating as sole proprietors, LLC owners, partners in partnerships, and S Corp shareholders.
You may deduct an amount up to 20% of your net business income. This is in addition to all of your other business deductions!
The pass-through deduction is a personal deduction that you can take on your tax return, whether or not you itemize.
This deduction is limited to people whose business involves providing personal services, including services in the fields of:
- Actuarial science
- Performing arts
- Financial services
- Brokerage services
- Investing and investment management
- Trading and dealing in securities or commodities.
There is an exception, though, for architects and engineers. They can take the deduction as well.
If you provide these types of services, you’re entitled to the 20% pass-through deduction only if your taxable income from all other sources after deductions is less than $157,500 for single filers or $315,000 if married filing jointly.
This deduction is phased out if your income exceeds the limits. And it disappears entirely for those single filers whose income exceeds $207,500 or married filers whose income exceeds $415,000.
Not involved in providing services? You can still qualify for a pass-through deduction if your business income exceeds $207,500/$415,000. But it will be wholly or partly based on how much you pay your employees and/or the value of your business property.
Advanced Strategies to Save Even More
So far, we’ve covered a lot, and there’s more. #HeadtoDesk
But not really, because all this stuff is saving you some serious cash.
Got it in you to keep going We’ve got two tax savings strategies that require quite a bit of planning ahead of time.
Form an S Corp
Want to know the most effective advanced tax savings strategy for most freelancers? Convert to S Corp taxation!
To do this, you have to first form either an LLC or a corporation in the state where your office is located. Then, you’ll need to obtain S Corp tax treatment by simply filing IRS Form 2553, Election by a Small Business Corporation.
Forming an S Corp reduces a lot of your self-employment tax burden.
Remember, self-employment taxes include the 12.4% Social Security tax and the 2.9% Medicare tax. Combined, that’s a 15.3% tax up to the Social Security tax ceiling (which is $132,900 in 2019). For many lower-income freelancers, self-employment taxes exceed their income taxes, so these taxes can be their largest single business expense. Ouch!
After you convert to S Corp taxation, you become an employee of your business, so you won’t be a sole proprietor anymore. Your business will start paying you an employee wage, along with benefits.
You and your business will need to pay employment taxes (Social Security and Medicare) on your wages. Although you and your business will each pay half of the employment taxes, the total tax is the same as for self-employment taxes (15.3% up to the Social Security income ceiling).
But here’s how you save money: you don’t pay employment taxes on distributions paid to you as a shareholder—that is, on earnings and profits that pass through the business to you as a shareholder.
The more your business pays you as a shareholder distribution, instead of as a salary, the less employment tax you and your business pay on your business profits. (You’ll still have to pay income taxes on your distribution, though.)
Now let’s say that you took no salary at all. What would happen? You wouldn’t owe any employment taxes, but you’d also be breaking the IRS’ rules, which requires S Corp shareholder-employees to pay themselves a reasonable salary (at least what other businesses pay for similar services).
Here’s a chart showing how much you can save in self-employment taxes when you start an S Corp. In this example, you would take 40% of your business profit as an employee salary, and 60% as a shareholder distribution.
|Business Income||S Corp Tax Savings*|
*Social Security and Medicare tax only
You can get more in-depth tips on how to determine your salary by reading our Freelancer’s Guide to Paying Yourself a Salary From an S Corp.
Deduct Medical Expenses as a Business Deduction
We already mentioned that you can deduct your health insurance costs as a personal income tax deduction to save money. But the tax benefits will be much greater if you deduct these costs as a business expense. That way, you reduce your self-employment taxes and your income taxes.
You can deduct health insurance costs as a currently deductible business expense if your business pays them on behalf of an employee. Unfortunately, if you’re a sole proprietor, partner, LLC member, or S Corp shareholder with more than 2% ownership of the business, you can’t be an employee of your own business for these purposes—and that’s the vast majority of self-employed people!
This means that you can’t have your business provide you with health insurance and deduct that cost as a business expense.
However, there’s a workaround: hire your spouse to work in your business as your employee, and provide him or her with family medical coverage.
Purchase the health insurance in the name of your spouse/employee, not in the employer’s name. The policy can cover your spouse, you, and your kids and other dependents. Plus, it can cover your children up to the age of 26, whether or not they’re your dependents.
Once all of this is done, you can then deduct the cost of the health insurance as a business expense. And you can also establish a health reimbursement arrangement (HRA) that lets you reimburse your spouse-employee for medical expenses other than insurance. Those reimbursements are tax-free. Pretty neat, right?
If you’re a single parent, you could hire your child and then deduct the cost of your child’s health insurance as a business expense. The only thing is that your child’s policy can’t cover you or other family members. Bummer.
But what if you’re single? Then you won’t be able to hire a spouse to take advantage of this strategy for turning health insurance costs into a business expense. Frustrating, we know.
Whoa, that’s a ton of information. Feeling like your mind is blown? We don’t blame you! It’s hard to navigate taxes as a regular employee; never mind as a freelance business owner! And that’s exactly why Collective is here to help.
When you sign up with Collective, you’ll gain access to valuable tools and experienced professionals who help you make all the right moves, from the moment you decide to register your business, to filing your tax return every year.
We can even help you save thousands in taxes by helping you manage your expenses and income, figure out the deductions that you qualify for, and ensure all of your paperwork is filed on time.
Stephen Fishman has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.