This article was written by Andi Smiles—a contributing writer at Collective—the first online back-office platform designed for self-employed people. Collective handles company formation, taxes, accounting, bookkeeping, compliance, and more.
You’re a freelancer, working diligently and managing leads while completing existing contracts. You’re totally focused on getting things done when—bam!—it’s tax season. You barely have time to respond to client emails, and now you also have to do your taxes.
We know how difficult this situation can be—managing your own freelance business and getting all of your tax paperwork together can be time-consuming and confusing. That’s why we want to help you get through this challenge by showing you how to take advantage of the best possible tax savings for your sole proprietorship or company.
Below, we’ll walk you through everything you need to gather to properly file your taxes , and we’ll also give you handy tips that you can implement to take advantage of the deductions that are worth using.
Trust us when we say this guide can serve as an invaluable tool, and we’ve made it easy to digest all of this information because we’ve broken up the guide into basic and advanced components. Work your way through the basic stuff first. Then dive into the more advanced tax considerations, which also include simplified steps, tips, and resources to help you move 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 this guide by covering the basic tax stuff you need to take care of:
1. 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.
If you don’t already, it’s a good idea to use Bonsai to manage your records. You can track expenses, identify write-offs, set tax reminders, and more from one easily managed platform.
- These are records that show how much money you earned in 2018. They include all Forms 1099-MISC that were sent to you by your clients. These forms will 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 or Venmo, 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 occurs only 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.
But, wait. 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. Then again, everybody doesn’t obey the speed limit either, yet speeders and tax evaders do get caught.
- 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.
Art by Mia Ditmanson
2. 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 will save 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% up to $124,400 in 2018. 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.
Note: Nondeductible commuting occurs when you drive from your home to a place of business. So, 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. For 2018, the rate is 54.5 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 gas, repairs, license and registration fees, insurance, and other expenses. And 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 must keep track of how many miles you drive for business during the year, and you must also track your total annual mileage (business and personal combined). You can do this with a mileage tracker app. If you didn’t do this last year, you might be able to reconstruct your business mileage by using your business calendar.
- 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 may 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 may 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 furnished to current or potential customers, consultants, clients, or similar business contacts in order for it to count towards this 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, for example, you may deduct 50% of the cost of taking a prospective client to lunch, but it isn’t necessary that you discuss business at this lunch.
- Whenever you buy property for your business that will last more than one year, you may deduct the cost.
- Due to recent changes in tax law, you can usually deduct the full cost in a single year. So, 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. Such 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. Easy enough, right?
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 would include the cost of designing and maintaining a website that you use for business, as an example.
- Other examples would include internet hosting fees, the cost of obtaining a domain name for your business website, and 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, as a couple of other examples.
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- 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. As an 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 prospects.
- 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.
- This deduction is 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.
Art by Eleni Debo
Let's tackle more complex tax saving strategies
Okay, here are some of the more advanced tax deductions that you might be able to take when you file your 2018 tax return. Ready? Let’s go!
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.
- 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.
- 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 exclusively as 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?
First off, the 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.
Next, the Individual 401(k) is an account that’s ideal for most freelancers because you can contribute a lot to it. As an example, for 2018, 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 2018 is $55,000.
Finally, the Simplified Employee Pension (SEP) IRA will let you contribute up to 20% of your net profit from self-employment every year as well, and the maximum amount for 2018 is also $55,000.
- 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, 2019 if you file your taxes by that date. On the other hand, if you receive an extension to file, you have until October 15, 2019 to establish and contribute to your IRA.
A 401(k), however, must have been established by December 31, 2018 to take a deduction for 2018.
- 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 corporation 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 health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, and trading and dealing in securities or commodities. There is an exception, though, for architects and engineers, so they can take the deduction as well.
If you provide such services, you’re entitled to the 20% pass-through deduction only if your taxable income from all other sources after deductions is less than $315,000 if married filing jointly, or $157,500 if single. This deduction is phased out if your income exceeds the limits. And it disappears entirely for those who are married filing jointly and whose income exceeds $415,000, or singles whose income exceeds $207,500.
- Not involved in providing services? You can still qualify for a pass-through deduction if your business income exceeds $415,000/$207,500. But it will be wholly or partly based on how much you pay your employees and/or the value of your business property.
Art by Paula Cruz
Start saving money on taxes
Everyone wants to save money come tax time, but they aren’t all well-versed in the top strategies that will allow them to do so, especially when they’re focused on running their companies and earning an income. Thankfully, by implementing the tax strategies above and accessing support from services like Collective, you can be a savvy freelancer, not only when it comes to the actual work that you do, but also when it comes to saving more money and using it to grow your business.
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