Filing your taxes as a self-employed freelancer might seem like a Y2K level disaster at first. But, once you get the hang of things, you’ll realize that planetary destruction is not imminent because you can take advantage of some helpful deductions.
Whether you’re working full-time or part-time, there’re lots of ways that you can save on taxes when you work for yourself.
What are some of the top tips from pros that can help you save big on your taxes as a freelancer? Check out our list of the six smartest tax strategies below, ordered from the least to most effective for tax savings.
Please keep in mind that, while we’ve made every effort to ensure this information is up-to-date and accurate, it doesn’t constitute legal or tax advice, and it shouldn’t be considered a substitute for legal or tax advice. When in doubt, always seek professional guidance from an attorney or tax expert.
Establish a health savings account
First up is establishing a health savings account, also known as an HSA. It’s like a medical IRA, so if you get sick, it’ll help cover your medical expenses.
What if you never get sick? Congrats on being a superhero and keep that HSA around because it still gives you major tax benefits.
To establish an HSA, you’ll need to go to a bank or other financial institution that offers HSA accounts. Ugh! Doing stuff- I know. But, don’t worry. It’s super easy to find a bank that’ll open an account for you and some are even online.
Just keep in mind that you must also get a high-deductible health insurance plan—which have lower premiums than plans with lower deductibles.
How can an HSA help you when tax time rolls around?
- You can deduct your annual HSA contributions from your income taxes every year, up to the annual dollar limits listed below.
- Any income that the money in your HSA earns will be tax-free.
- If you make withdrawals to pay for health-related expenses, they’ll be tax-free. Withdrawals for nonmedical expenses will be taxed and penalized.
- Once you reach the age of 65, or if you become disabled, you can withdraw your funds from your HSA for any reason without penalty. And if you use the money for nonmedical expenses, you’ll only have to pay regular income tax on those withdrawals.
The other nice thing about an HSA is that the money you put into it is yours FOR-EVA.
How much can you contribute to your account every year? There’s no minimum amount that you’re required to contribute annually, which means you don’t have to contribute anything if you don’t want to.
But if you have individual coverage, the max you can contribute to your HSA for 2019 is $3,500. And if you have family coverage, the max you can contribute is $7,000. If you’re over 50, you can add $1,000 to your annual HSA contribution.
Time year-end income and expenses
Virtually all freelancers use the calendar year as their tax year, and they’re cash basis taxpayers.
Wait, what does cash basis mean? It means you count money as income only in the year you receive it. And you deduct an expense in the year that you paid for it.
Why does this matter? Because it lets you do some clever tax planning at the end of the year.
Want to minimize your taxes for the year? Well, you could defer income and speed up paying deductible expenses.
One way to defer income is by refraining from billing clients until the following year. Keep in mind that you can’t avoid having taxable income by simply not cashing a check until the following year.
Under a legal doctrine known as constructive receipt, you must count income as any money or property made available without restriction during the year. That means a check counts as income when you receive it, not when you cash it.
You can also opt to increase your deductible expenses for the year by buying things for your business prior to the end of the year. The best part is that you don’t even have to pay cash for it by December 31 in order to take advantage of the deduction. Instead, you can use your credit card and deduct the full amount of the expense.
Establish a retirement account
Another way to save on taxes and take care of your future self is by establishing and funding a retirement account.
How does it lower your taxes? It’s simple: you can deduct the amount that you contribute to a tax-qualified retirement account from your income taxes.
Side note: This doesn’t apply to a Roth IRA or Roth 401(k).
On top of that, you don’t have to pay taxes on investment earnings from retirement accounts until you withdraw the funds. Just remember: early withdrawals before the age of 59½ are subject to a 10% penalty.
It’s super easy to establish a retirement plan with a bank, mutual fund, or other financial institution. Plus, with these accounts, you don’t have to make contributions every year, and your contributions can vary from one year to the next.
Oh, and you can invest your money in almost anything (mutual funds, stocks, bonds, and notes).
There are a few different types of retirement accounts available to freelancers like:
- Traditional IRA: This can be established for any individual. For 2019, you can contribute up to $6,000 and deduct the full amount if you and your spouse have no other workplace retirement plan.
- Individual 401(k): This is ideal for most freelancers because it lets you contribute a lot. For 2019, you can contribute 20% of your net profit from self-employment, plus an elective deferral contribution of up to $19,000. And the maximum contribution for 2019 is $56,000. See what we mean? It’s a lot!
- Simplified Employee Pension (SEP) IRA: This allows you to contribute up to 20% of your net profit from self-employment annually, up to a max of $54,000 for the year 2019.
Rather than establishing a regular IRA or a 401(k), consider opening a Roth IRA or Roth 401(k). While you don’t get a tax deduction for your contribution, you don’t have to pay any tax on withdrawals that are made after the age of 59½.
Also, if you’re 50 or over, you can make additional tax-deductible catch-up contributions to these accounts. For IRAs, you can put in an extra $1,000, while for a 401(k), you can put in another $6,000.
Track and deduct business expenses
As a freelancer, you can deduct almost anything that you buy for your business, as long as it’s necessary and the cost is reasonable.
Below are some of the most common business expenses for freelancers:
Spending money on things you need for your office is considered a deductible expense. As an example, you might deduct your utilities and rent.
Work from home? Then you might be able to deduct the cost of your home office—this is especially valuable if you rent because it lets you deduct a portion of your monthly rent, which can be a sizable expense that’s ordinarily not deductible!
Advertising and marketing expenses
Spending money to promote yourself and your business? It’s a deductible expense!
For example, this category would include the cost of having your website designed and maintained, and include hosting fees for your site, the cost of getting a domain name, and the cost of plugins and themes..
You could even deduct the cost of brochures, business cards, listings in directories, having someone help you with your resume, and more.
Keep track of the costs associated with any driving that you do for business.
The only important exception here is the cost of commuting (to clarify, nondeductible commuting is when you drive from your home to your principal place of business). The rest is tax-deductible, and there are two ways to figure out this deduction.
First, you can keep track of all of your car expenses, such as gas and repairs, and deduct the business percentage.
If you’d rather not keep track of how much you spend on gas, oil, and repairs, you can use the standard mileage rate. When you use the standard rate, you only need to track how many miles you drive for business, not how much you spend on the car.
For 2019, the standard mileage rate is 54.5 cents per mile. Either way, you have to track your business mileage. Sound like a drag? There are a lot of smartphone apps, like Mile IQ, that make it mileage tracking quick and easy.
Don’t forget to deduct expenses that you incur when you go out of town for your freelance business.
These travel expenses could include airfare or other transportation costs, like hotels, Air BnBs, and taking taxis or Lyfts.
Note: You may only deduct 50% of the cost of meals when you travel on business.
You get a deduction whenever you purchase tangible personal property that lasts more than one year.
So what’s tangible property? Examples include office furniture, computers, and even business-related books. Nice, right?
The full cost of this property can usually be deducted in a single year using100% bonus depreciation (in effect through 2022), Section 179 expensing, or the de minimis safe harbor (applicable to property that costs $2,500 or less).
Legal and professional services
Have you paid attorneys, accountants, consultants, or other pros for work related to your freelance business? Write those babies off!
Simple and straightforward, and a nice way to save on taxes when you’re self-employed.
Any insurance that you buy is deductible.
For example, business liability insurance, or insurance for business property, can be deducted from your taxes. Plus, if you have a home office, you can deduct a portion of your homeowner’s insurance.
And self-employed individuals are even allowed to deduct 100% of their health insurance premiums from their income taxes (this is a special personal deduction, not a business deduction).
Take the pass-through deduction
Thanks to the Tax Cuts and Jobs Act, which established a brand new deduction, owners of all of these types of businesses can deduct from their income tax up to 20% of their net income from the business. This is referred to as the pass-through deduction.
To clarify, if you earned $100,000 in profit from your freelance business, and you qualify for the pass-through deduction, you may deduct up to $20,000.
It’s more complicated if your taxable income is over $157,500 if you’re single or $315,000 if you’re married and filing jointly. In those cases, your deduction is based wholly or partly on how much you pay your employees and/or the cost of the property you use in your business. If you have no employees and little or no expensive business property, your deduction will be quite small.
Also, business owners who perform certain types of services aren’t entitled to take the pass-through deduction of their taxable income exceeds $207,500 if single or $415,000 if married filing jointly.
Those services include:
- Actuarial science
- Performing arts
- Financial services
- Brokerage services
- Investing and investment management
- Trading and dealing in securities or commodities
This handy deduction took effect on January 1, 2018 and is scheduled to last through December 31, 2025. Be sure to take advantage of it while you can!
Convert to S Corporation taxation
The best strategy for freelancer tax savings is…drum roll, please…converting to S Corp taxation! Think of this as the freelancer’s tax savings paradise.
By changing into an S Corp, you can free yourself from a lot of your self-employment tax burden. And that’s important because self-employment taxes consist of the 12.4% Social Security tax and 2.9% Medicare tax. Combined that’s a total tax of 15.3% (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, and these taxes are their largest single business expense. Ouch! But, even for higher-income freelancers, self-employment taxes are a significant burden.
No matter what you earn, when you convert to S Corp taxation, you completely change your tax life.
That’s because you’ll become an employee of your business, which means you won’t be self-employed anymore. Instead, your business will pay you wages and benefits as its employee.
This also means that, as an S Corp, you and your business must pay employment taxes (Social Security and Medicare taxes) on your employee wages. You and your business each pay half of these taxes, with the tax being the same at 15.3% (up to the Social Security income ceiling).
And here’s where S Corp taxation is super helpful: you don’t pay employment taxes on distributions paid to you as a shareholder. In other words, the earnings and profits that pass through the business to you, the owner, aren’t subject to self-employment tax.
The more your business pays you as a shareholder distribution, the less employment tax you and your business pay. You do, however, still have to pay income taxes on your distributions.
This chart shows how much Social Security and Medicare tax you can save with S Corp taxation when you take 40% of your business profit as employee salary and 60% as a shareholder distribution:
*Social security and Medicare tax only
What if you took no salary at all? You wouldn’t owe any employment taxes BUT that’s a big no-no., The IRS requires that S Corp shareholder-employees pay themselves a reasonable salary that’s at least what other businesses pay for similar services.*Social security and Medicare tax only
Need more info on how to establish your salary while running an S Corp? Check out our Freelancer’s Guide to Paying Yourself a Salary From an S Corp.
Want to convert your business to an S corporation?
You’ll have to form either a corporation or limited liability company (LLC) first, and you’ll do this in the state where your office is located. Then you’ll obtain S Corp tax treatment by filing IRS Form 2553, Election by a Small Business Corporation.
To make the process of transforming your sole proprietorship into an S Corp even easier, you can enlist the help of Collective. We help you establish your S Corp, and file all the right paperwork on time so you maintain your status long into the future.
On top of that, you’ll receive expert guidance from professionals in finance, accounting, and taxes so that you can run your business like a pro and save the most money possible come tax time.
Now you’re ready to save big on taxes!
See? Dealing with your taxes is way easier than preparing for a global tech meltdown. ? With these six tips you can start crushing your taxes and saving some serious dollars come tax time.
Stephen Fishman writes for Collective and is an attorney and author who writes useful and recognized guides on taxes and business law for freelancers. He is the author of over 20 books and hundreds of articles.
Ugur Kaner is the co-founder and CPO of Collective, the first online back-office platform designed for self-employed people.