Whether you’re new to freelancing or someone who’s been self-employed for decades, you probably know that tax season can bring with it a great deal of financial uncertainty. Unlike traditional workers, contractors don’t have portions of their paychecks removed by employers for tax purposes. Instead, freelancers are responsible for making their own quarterly tax payments throughout the year.
Because failure to make accurate projected payments can result in IRS penalties, it’s essential that contract employees calculate their expected tax burdens carefully. Furthermore, freelance workers are also responsible for the self-employment tax, which includes contributions to Social Security and Medicare.
Whereas the employer pays half of the tax on Social Security and Medicare for traditional workers, self-employed persons must take on the entire burden alone. Fortunately, as freelancers, you can deduct half of the Medicare and Social Security fees normally paid by employers. Claiming this deduction, as well as all other legal tax deductions, is the best way to guarantee your future financial stability as a freelancer.
What Tax Deductions Can Freelancers and the Self-Employed Claim?
Whether you’re an independent contractor, a small business owner or a member of a partnership, it’s important to track your tax-deductible expenses throughout the year.
In general, self-employed individuals can deduct any business expenses considered “both ordinary and normal” from their tax liability. An “ordinary” expense is common and accepted in your trade or business, whereas a “necessary” expense is helpful and appropriate for your trade or business.
Below are some of the largest potential tax write-offs for the self-employed.
A retirement plan is one of the most significant tax deductions for freelancers. Self-employed persons can dedicate $17,500 plus 25% of net income into an individual 401(k) account (as of 2013). The $17,500 contribution is tax-deferred, meaning you only pay taxes on the income when you make withdrawals from the retirement account.
This provides two benefits. First, the contribution is deducted from your income for the year, meaning you only pay taxes on the cash you earn minus the 401(k) contributions. And second, depending on how you spend your money throughout your lifetime, you might find yourself in a lower tax bracket when you make withdrawals during retirement, so you’ll pay less taxes than when you have higher earning power throughout your career.
Not only is contributing to a retirement account a great way to reduce your tax burden, but it’s also essential to safeguarding your financial future.
Home Business Costs
Are you operating your business from the comfort of your own home? If you do, it’s worth pointing out that self-employed individuals enjoy the benefit of deducting those expenses related to the business use of their homes.
Some of those potential tax write-offs include phone bills, internet costs and even a portion of their rent and electricity. For both homeowners and renters, the deductible amount is based on the percentage of your home devoted to business activities. For example, if your home office is a small bedroom that takes up 10% of your entire house’s square footage, you can deduct 10% of your rent/mortgage and applicable utilities.
Keep in mind, however, that you must regularly use that section of the house exclusively for business, and you must be able to prove that it’s your principal place of business.
Does your small business or contracting work require you to travel? If so, self-employed individuals can deduct a portion of their driving costs at the standard mileage rate. You can also deduct airplane, train, bus and even taxi fares, as well as business-related tolls, parking fees and rental car costs. Lodging is also tax-deductible, as are meals, tips and dry cleaning when meeting with clients.
Business travel deductions depend on how much of your trip is related to your business. Because of this, travel deductions are giant red flags for auditors, so be extremely careful when making claims. You cannot deduct expenses that are lavish or extravagant, and they must be strictly for business. For example, if you want to catch a ballgame while on a business trip, unless you’re a scout or your work involves baseball, you cannot deduct any expenses for the game.
Thinking of going back to school to further your freelance career? As a self-employed person, you may be able to write off education-related expenses, including college classes, online courses, books and other materials.
In order to qualify for education deductions, you must meet one of the following two requirements:
- Education is required by a client or law to keep your present salary, status or job.
- OR it must maintain or improve skills needed in your present line of work.
Marketing and Labor Costs
Marketing expenses are tax write-offs that are unique to the self-employed. These deductions may include graphic design expenses, business incorporation fees and even materials like letterhead and stationary.
Additionally, small businesses can deduct the cost of labor, including pay for freelance employees and advisors such as accountants, lawyers, assistants, headhunters and business planners. In a similar vein, self-employed persons can also deduct the cost of unpaid invoices. If a client fails to pay a bill for services rendered, come tax time, freelancers can write off the loss.
Since the passage of the Affordable Care Act, it’s mandatory that every individual have a health insurance plan. As a self-employed person, you can deduct the cost of any medical, dental or long-term care insurance premiums for yourself, as well as the cost of plans for your spouse, dependents and children under age 27 (even if they’re not dependents).
Writing off health insurance costs is a great way to limit your tax burden while safeguarding your family’s health and avoiding government penalties.
Reduce Your Tax Liability
It’s no secret that new businesses face a number of challenges, including high startup costs. But as a freelancer, you can take steps to limit your tax burden and alleviate a bit of those expense.
Do your research to determine what expenses can be legally written off, and be sure to keep extensive records of these business expenditures. When in doubt, contact an accountant or tax professional for advice. Different software can also facilitate the process. Understanding all of your potential tax deductions is the best way to guarantee your success as a self-employed person.