Make the most of freelancer tax deductions
Small Business Guides
6 min read
What does the US Tax Code have in common with 12 copies of the King James Bible? They’re the same length. That’s right, the US Tax Code is 10 million words long. Fortunately you don’t have to know it all to save some money.
Learn the basics and save
If you’re confused by tax legislation, you’ve got good reason to be. Freelancers enjoy a lot of benefits – but a simple tax system is certainly not one of them. Throw in the added risk of an IRS audit, and freelancer taxes can be tough.
But it’s not all bad news. If you make the most of freelancer tax deductions, you can reduce the amount of tax you have to pay each year. Learning the basics can be enough to save you hundreds, or even thousands of dollars.
Freelancers have different tax obligations
Whether you freelance full-time or dabble on the side, freelancers still have to pay taxes. If you earn more than $400 freelancing in a year, you’ll need to pay tax on that income.
Freelancer tax obligations differ from those of employed workers. You don’t have the convenience of an employer withholding tax from your paycheck, so it’s up to you to figure out how much tax you owe and how you’re going to pay it.
This can be daunting. Luckily, there’s an ace up your sleeve: the tax deduction.
Introducing the tax deduction
One of the biggest advantages of freelancing is the ability to make freelancer tax deductions. This is when you deduct a business expense from your taxable income.
Taxable income is the amount of income you pay taxes on.
By reducing it, you reduce the amount of tax you have to pay.
But how do tax deductions work exactly? Imagine you’re a freelance photographer with a yearly income of $60,000. Let’s say you owe 30% of that as tax (a simplified estimate for argument’s sake).
$60,000 income × 30% tax = $18,000
So you’ll owe $18,000. But this year you spent $2,000 on a new camera and some lenses for your business. You can deduct that $2,000 as a business expense.
But you don’t remove that $2,000 directly from your $18,000 tax bill – that would be a tax credit. Instead, you reduce your taxable income by $2,000. This means you’ll now only pay tax on $58,000 of your $60,000 income.
$60,000 income - $2,000 business expense = $58,000 taxable income
$58,000 taxable income × 30% tax = $17,600
This reduces the amount of tax you’ll pay to $17,600 – a saving of $400 from one deduction. It’s easy to see how these savings can add up.
Make sure your tax deductions are legal
Don’t make the mistake of thinking freelancer tax deductions apply to everything. The IRS states a business expense must be:
ordinary – common in your line of work
necessary – it doesn’t have to be indispensable but it must be helpful for your business
This means buying a camera is a legitimate business expense for a photographer – but not for a writer. As a general rule, if you buy something that you would have got anyway (even if you weren’t freelancing), it’s not a business expense.
You can’t deduct personal expenses, like groceries and clothing. But if an expense is partly business and partly personal, you can deduct the business portion. Let’s say you buy a new cell phone and use it for business 80% of the time, and for personal use 20% of the time. You’re allowed to deduct 80% of that cost.
Besides equipment necessary for your job, you can also deduct:
50% of self-employment tax
marketing and advertising
tax preparation software
This isn’t an exhaustive list. To make the most of freelancer tax deductions you should consult a bookkeeper or accountant – whose services are also tax deductible.
If you’re confused by tax legislation, you’ve got good reason to be.
Hold onto your receipts
If you’re making tax deductions, it pays to keep your receipts in case the IRS ever comes knocking.
Physical receipts can get worn or lost, so it’s safer to take photos of them. Store these photos in a “business expenses” folder, then name each image with the purpose and date of the expense. For example, if you bought a new camera on 12 May 2016, you might name the image of the receipt “160512-camera.” This goes for meal and travel receipts too, for instance “161015-gas.”
If you use Xero, you can email the photo to your files inbox in Xero and store them there. You can also attached them to the related transaction.
Keep track of your taxes as you go along
Nobody likes digging into savings to cover an unexpectedly high tax bill. That’s why it’s important to keep track of the tax you owe throughout the year. The best way to do this is to keep this money separate. Each time you get a paycheck, set aside roughly 30% – and don’t touch it.
As your freelance business grows, you might decide to invest in accounting software. Accounting systems can be connected to your bank account, which allows you to track all your expenses. Each day, you can run through your transactions and categorize the business expenses as freelancer tax deductions. That way you’ll have a better idea of how much tax you owe throughout the year.
You could also hire an accountant or a bookkeeper to help keep you on top of it all. They can set up your accounting software, if you go that route.
Tax forms that freelancers need to file
The final step is filing your taxes and reporting your deductions. These are the forms you’ll need:
Form 1040: reports your total income for the year
Form 1099: reports the income you earned from each client. Clients who paid you $600 or more should send it to you by January 31
Schedule C: reports your business expenses and tax deductions
Schedule C-EZ: you can file this instead of a Schedule C if:
– your expenses were less than $5,000
– you have no employees or inventory
Depending on your work, you may have to file additional forms. If you freelance alongside a full- time employed job, for instance, you’ll also have to file a W-2. Check out the IRS tax center for more information on which forms apply to you.
When do freelancers have to file taxes?
If it’s your first year freelancing, you can file all your taxes at once on April 15. If you’ve already been freelancing for a year, you’ll have to pay taxes quarterly if:
you paid $1,000 or more in taxes last year
you expect to pay $1,000 or more in taxes this year
Quarterly tax payments must be made by:
April 15 for earnings between January 1 and March 31
June 15 for earnings between April 1 and May 31
September 15 for earnings between June 1 and August 31
January 15 for earnings between September 1 and December 31
If you should be paying quarterly, but don’t, the IRS could hit you with a late payment penalty. This is 0.5% interest per month on the amount of tax you owe.
Tax deductions are worth the effort
Benjamin Franklin once said, “nothing can be said to be certain, except death and taxes.” Freelancer taxes can be confusing and frustrating. But with a little diligence you can save hundreds of dollars a year with tax deductions.
To get the most out of freelancer tax deductions, it’s worth investing in the services of a professional – whether an accountant or bookkeeper. They’ll likely pay for themselves with what they save you.
To hear about other freelancers’ experiences, check out the Xero Gravity podcast: