Top Tax Tips for the Self-Employed

When you’re a business owner or an independent contractor, tax season can be a nightmare. Sorting your myriad income sources and wrangling 1099s without the guidance of a full-time employer is daunting. Worse, new freelancers unfamiliar with their entitlement to business-related tax write-offs may find themselves paying more than they owe.

But don’t worry — we’re here to help. Armed with these tips, you can tackle your taxes without fear or anxiety, and get all the tax deductions you deserve.

Track your spendingTrack business expenses

This sounds simple, but tracking all business spending requires constant vigilance. In order to deduct them, you’ll need records of every receipt for all your business expenses.

Do you save your receipts in a file? Since paper can fade or get damaged, you might want to invest in a scanner, or at least download a scanner app on your phone. This way you can keep all of your records safe in the cloud.

One simple and effective way to organize your business expenses is to set up a separate bank account for your business. Then get a separate credit card to pay for your business and healthcare expenses. Choose a business-specific card with a generous points or cashback program. This way, you’ll have an accurate record of all of your business expenses, without having to keep a rigorous file.

Know what you owe

Employees with full-time positions usually rely on their employers to manage their Social Security and Medicare taxes, explains Melinda Kibler, Certified Financial Planner at Palisades Hudson Financial Group.

“When you are an independent contractor, however, this becomes your responsibility, and you must pay both the employer-equivalent and employee-equivalent portions, using Schedule SE to calculate,” she says. “However, you can also take a deduction for the employer-equivalent portion of your self-employment tax when figuring your adjusted gross income.”

If you’re self-employed and expect to make more than $1,000 for the year, it is also your responsibility to make federal estimated tax payments. That’s because without a formal employer, there will not be any structured tax withholding on your income.

Kibler says, “These payments are due April,  June, September, and January 15 of the following year. You may have to pay a penalty if you do not meet the estimated tax requirements throughout the year. The IRS requires you pay 100% of the tax shown on the prior year return, or 110% of the prior year tax for high-income taxpayers, or at least 90% of the tax for the current year. If you live in a state that taxes income, you may also need to pay state estimated taxes depending on their rules.”

Also, remember that self-employment income includes all pay you receive for part-time work you do out of your home. This could include additional income from side-hustles like driving Uber or walking dogs, as well as your primary contract income. You’ll have to account for all of these income sources when filing your taxes.

Open a tax savings account

Since they don’t have a primary employer withholding your taxes throughout the year, freelancers get hit hardest when tax season swings around.

Don’t make the mistake of thinking all that freelance money is yours to keep. To avoid the temptation of spending money that isn’t yours, open a tax savings account separate from your personal savings account. Get in the habit of depositing about 30% of every check you receive. It will hurt to part with your hard-earned cash, but it’ll be worth it when you can easily afford to pay what you owe.

Deduct your health insurance premium

If you’re new to the freelance world, you’re probably still shell-shocked by the cost of health insurance premiums. Losing health benefits is what keeps many workers from making the leap into self-employment in the first place.

The good news is that, as a freelancer, you can deduct all your healthcare insurance premiums. If you are transitioning from a previous job, that includes COBRA costs. However, health insurance deductions only reduce your income tax, not your self-employment (SE) tax.

If you’re married, there’s a loophole to use health insurance deductions to reduce both self-employment and income tax. Just hire your spouse and provide them with family health insurance coverage. This works because health insurance coverage for employees is an expense that reduces both your income tax and SE tax.

Deduct your auto expenses

There are two different methods for estimating your business auto expenses: standard and actual.

In the standard method, your auto expenses are equal to 53.3 cents per business mile, plus tolls and parking.

For the actual method, just add up all your automobile expenses for the year, and then multiply that by your “business percentage” (business miles/total miles for the year).

Of course, for either of these methods to work, you must have rigorously tracked your vehicle expenses over the course of the year.

Gail Rosen, partner at Wilkin & Guttenplan, P.C., advises trying both methods to see which one is better for you. ”Remember, you save a lot of money if one method is better than another,” she says. “However, there are restrictions on switching between methods after the first year.”

Note: Home office businesses have a tax advantage here, because anytime you leave your home for business purposes, those miles are deductible, explains Rosen. If you have an office, on the other hand, your daily commute is not deductible.

Take the home office deduction

To take the home office deduction, your business must operate exclusively out of your home. If you occasionally take off-site meetings with clients, you may still qualify, but if you rent business property elsewhere, you likely won’t.

There are a couple of ways to calculate this deduction. If you use the actual expenses method, you can deduct direct expenses (like paint, wallpaper, and carpeting installed only in your office) in full. And you can deduct indirect expenses (like mortgage interest, home insurance, utilities, etc.) in part, based on the percentage of your home used for business.

To simplify the process, the IRS provided a simplified rule. To calculate home office expenses using this method, just multiply the square footage of your home office by $5 (for a deduction of up to $1,500).

Again, Rosen recommends comparing the simplified method with the actual method to see which one generates a better deduction. “You can switch each year which method you choose for the home office deduction,” she says.

tax tips

Deduct business-related travel

If you’re self-employed, you can deduct any travel expenses when the travel is for your business. So keep track of everything when your trip is related to your business. Keep (and scan) airfare costs, restaurant receipts, hotels, etc. It’s all a write-off.

However, remember that you may only deduct costs that are deemed both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. When claiming these deductions, be sure that they will hold up to potential scrutiny, and that you can defend them as viable business expenses.

Contribute to your retirement

Noel Dalmacio of Dalmacio Accountancy suggests that you put as much as you’re able to into a retirement plan. Since money put into retirement accounts isn’t typically taxable until you withdraw it, this can save you a lot in taxes.

He explains that you can put up to $18,000 in a 401(k) (and an additional $6,000, if you are 50 or over). “Also, you can contribute up to 25% of your salary to a profit-sharing plan. Your overall contribution limit is $54,000 ($60,000 if you are 50 or over).”

Conclusions

Filing taxes as a freelancer can be messy, especially if you’re juggling multiple freelance positions. When in doubt, consider hiring a tax preparation professional with experience dealing with freelancers. While they do cost some money up front, self-employed workers are sitting on a treasure trove of potential deductions, and only a trained professional can unearth all of them.

Ready to get started? Click here to compare ratings and reviews of the top tax prep firms, and find a tax worker that you can trust.