10 Tax Tips for Freelancers and Contract Employees
One of the best parts about being a freelancer or independent contractor is that you can take a few deductions without having to itemize your entire tax bill.
In reality, who cares about taxes? The best part of being a freelancer is that you don’t have to put on real pants, your cattiest colleague is actually your tabby, Mr. Ribbons, and nobody gets mad at you if you eat the rest of the cake in the fridge for lunch. But to be fair, being able to write off certain expenses as business costs is pretty nice too.
Let’s take a look at a few different tips to help independent contractors and the self-employed get a little tax relief. Our first tip? Find out if you’re actually a freelancer, anyway.
10: Know If You’re a Freelancer/Contractor
In IRS parlance, any work you do as a nonemployee for a client or company — be it freelance work or contract work — makes you an “independent contractor.” And best you know if you are, in fact, considered an independent contractor, lest you be accused of evading the IRS without knowing it.
The rules are pretty simple: If you’re being paid more than $600 by any individual client, then they’re obligated to report it to the IRS. If you are not an employee of that company, that’s self-employment income, and that means that the IRS is watching for your tax return to match up as well.
Don’t think you’re in the clear if you’re a full-time employee somewhere and just taking a little bit of the freelance pie when you can. If you make more than $400 from a self-employed enterprise, you have to report the income to the IRS [source: Lerner].
9: Keep Good Records
Sounds obvious, right? Well, you’d be surprised at how few independent contractors have a system for keeping track of their income, expenses, deductions and estimated taxes. (Oh yes, we’ll get to that tax treat later.)
Obviously, good old paper receipts for costs or business expenses are useful — but aren’t necessarily the best strategy. They’re hard to keep track of, for one, and even something like faded ink can make it hard to back up your purchases if you’re ever audited. It might be wise to invest in a scanner so that you can immediately upload images of your bills or receipts. That way, you have both a hard copy and a digital copy. Beyond that, it’s really important that you have an organized system for keeping — and finding — your income and expenses.
8: Get Financial Software
Don’t know your expenses from your assets? You might want to take a crash course in some bookkeeping basics. If you’re not entirely sure you want to take accounting classes at the community college, consider buying some financial software for an easy shortcut.
There are some obvious benefits of having a digital accounting system at your fingertips that don’t even have to do with taxes. Consider that you can keep track of invoices and billing, for instance. You can even run reports on your financials to help with marketing or sales.
But the big advantage come tax time is that you’ll have an organized, efficient way to access the history of your income and expenses. Some programs even let you e-file some of your tax documents straight from the software. And remember that if you are audited, you’ll need to provide detailed records to the IRS. A bookkeeping system might just save you a huge audit headache should the IRS come calling.
7: Know Your Deductions
While we’ll go into a few of the most useful deductions, the broader message is important: Know what deductions are available, and don’t be shy about claiming the ones that apply to you. Self-employed workers can also take a few more deductions above the line, which means they can still take the standard deduction while also writing off a couple more items. (Essentially, they’re included as “business expenses” instead of miscellaneous deductions.)
It’s important to note here that you can either take a standardized, flat deduction or itemize all your deductions based on your expenses. For most people, taking the standard deduction is going to be easiest, but if you have a ton of expenses, you may save money by itemizing. But to even begin getting deductions, you have to exceed two percent of your adjusted gross income. Do your research and see what’s best for you.
6: Take the Simplified Home Office Break
One of the most popular write-offs for self-employed folks is the home office deduction. Unlike those suckers with full-time jobs, self-employed workers can take the home office deduction (and its associated direct and indirect expenses) without having to itemize. Basically, you can still get that sweet standard deduction, plus the deduction for the associated costs of your home office.
Not that the IRS is letting you call any old slab of counter a home office. You have to meet some strict requirements. For one, your office space must be used pretty much exclusively and regularly for only your business. (Good luck trying to claim the top of your air hockey table in the kids’ playroom as a work space.)
But the good news is it’s now easier than ever to figure out the deduction if you do qualify. It used to be that you’d have to figure out the business percentage of all your home office expenses (including bills and utilities) to claim the correct deduction; now you can simply multiply the square footage of your home office by $5 (for a deduction of up to $1,500) to get a much more simplified deduction. Unless you have a very large office or your expenses will equal more than $1,500, make it easy on yourself and use the simplified method.
If you’re self-employed as an independent contractor, do remember that you can write-off any business travel expense, so long as it’s for an overnight trip away from your tax home. (Tax home being the place you run your business.) If your entire trip is business-related, you can deduct the whole thing. But if it’s a mix of business and personal, you need to keep track of the business side and be sure to deduct only that amount. Stopping by your parents’ place to take the folks to Applebee’s after a business trip isn’t going to make the cut, in other words.
You can also deduct meals, both during business-related travel or for business-related entertainment. Which sounds amazing, right? But keep in mind you can generally only deduct up to 50 percent of the cost of your meals, and the IRS is totally on to you: They make a point of excluding “lavish or extravagant” meals. You can also use the standard meal allowance if you weren’t keeping track of the actual cost. Each state sets a per diem amount that is a useful shortcut for deducting business meals [source: U.S. General Services Administration].
4: Remember to Pay Estimated Taxes
So far, it’s been all rainbows and roses when it comes to tax tips. Remember to get that sweet home office deduction! Buy some cool software! But now we get into the darker side of filing as an independent contractor: estimated taxes.
Obviously, when you’re self-employed, no employer is withholding taxes from your paycheck. So that means you and you alone are responsible for taking a chunk out of every check you get and squirrelling it away for Uncle Sam. There’s no flat rate that every freelancer should set aside, considering that state taxes vary so much — so you might want to check with an accountant in Ashburn to be on the right track. (Don’t forget you’re paying your own self-employment tax too, to cover Medicare and Social Security.)
And if you’re profitable — meaning that you’re making more than $400 a year — you’re also going to have to provide those tax payments quarterly. The IRS wants your money all year long, not just at the end: They’ve set aside four due dates during the year for you to make quarterly payments (although you can pay more often throughout the year if that’s easier for you).
3: Health Insurance
Enough of the dismal stuff. Here’s some more good news: If you’re an independent contractor, you can deduct all your health insurance premiums without itemizing them. (Again, that means you can take an above-the-line adjustment, which will reduce your entire adjusted gross income.) Even more, you can also deduct the cost of your spouse’s and dependents’ health premiums.
But how about this for a nifty trick: If you really want to reduce your taxes as a self-employed worker, hire your spouse. If you provide your significant other with health insurance as an employee, you can deduct the cost of said insurance from your self-employment income and tax, so long as you’re included on the plan.
2: Open a Retirement Fund
Another problem with freelancing? You have no employer helpfully setting up a retirement plan for you — and you definitely don’t have anybody but yourself contributing to any kind of retirement fund. You’re pretty much stuck taking a chunk of your income and having the discipline to set it aside for your twilight years.
But that doesn’t mean that you don’t get a little something out of it come tax season. As a self-employed person, you can contribute up to 25 percent of your net earnings from self-employment — to a max of $52,000 in 2014 — to a Simplified Employee Pension (SEP) IRA. You can also contribute up to $12,000 to a SIMPLE IRA if you’re a sole proprietor [source: IRS]. All those provide above-the line deductions, and some other IRA accounts will be able to be deducted up to a certain amount [source: Fishman].
1: Employ the Kiddies
OK, you’ve waited this long, so now it’s time we gave you self-employed independent contractors the best, and perhaps most absurd, tax tip of all: Hire your babies. Need some help transcribing meetings? Surely little Susie will do it for $5 an hour. Need to paint the office? Timmy’s cheap. Heck, maybe you can convince Sally to file your taxes for you!
It’s not just that your kids are easily manipulated and always around. It’s that you can deduct their wages on your Schedule C (business profit and loss) form. If they’re under 18, they’re exempt from Social Security tax, and if they’re under 21, they don’t have to pay Federal Unemployment Tax either. They probably won’t have to pay taxes at all if they’re not scamming you out of too much money — and that money you’re paying them isn’t counting toward your taxable income either. Just remember that you do have to pay reasonable wages. But hey, no need to be a scrooge: You can even contribute to IRAs for them.
Author’s Note: 10 Tax Tips for Freelancers and Contract Employees
Here’s something even better: If you don’t want to make your kids think their time is worth cash, just deduct the cost of some of the things you already pay for on their account. If you’re paying their phone bill, you can just claim their wages are $49.98 a month, or whatever the bill is. Buying them $75 worth of back-to-school clothes? They’ll make up for it answering phones for you.
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- Fishman, Stephen. “Above-the-Line Deductions You Can Take Without Itemizing.” Nolo. 2014. (Oct. 4, 2014) http://www.nolo.com/legal-encyclopedia/deductions-you-can-take-without-itemizing.html
- Fishman, Stephen. “Being a Consultant, Freelancer or Contractor.” Nolo. 2014. (Oct. 4, 2014) http://www.nolo.com/legal-encyclopedia/being-consultant-freelancer-or-contractor-29593.html
- IRS. “2013 Instructions for Schedule C.” 2013. (Oct. 4, 2014) http://www.irs.gov/pub/irs-pdf/i1040sc.pdf
- IRS. “Retirement Plans for Self-Employed People.” March 19, 2014. (Oct. 4, 2014) http://www.irs.gov/Retirement-Plans/Retirement-Plans-for-Self-Employed-People
- Lerner, Michele. “The Finances of Freelancing.” The Tax Center. Jan. 31, 2013. (Oct. 4, 2014) http://www.dailyfinance.com/2013/01/31/freelancing-tax-tips-contractors-1099-form/
- Quickbooks. “About E-File.” Intuit. 2013. (Oct. 4, 2014) http://support.quickbooks.intuit.com/support/pages/inproducthelp/Core/QB2K12/ContentPackage/Payroll/Taxes/pay_ov_efile_general.html
- Shin, Laura. “Freelancers, Here’s How to Do Your Taxes.” Forbes. July 18, 2014. (Oct. 4, 2014) http://www.forbes.com/sites/laurashin/2014/07/18/freelancers-heres-how-to-do-your-taxes/
- TurboTax. “Tax Topics for Freelancers, Contractors and Consultants.” Intuit. 2013. (Oct. 14, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/Self-Employment-Taxes/Tax-Topics-for-Freelancers–Contractors–and-Consultants/INF12025.html
- U.S. General Services Administration. “Per Diem Rates.” 2014. (Oct. 4, 2014) http://www.gsa.gov/portal/content/104877?utm_source=OGP&utm_medium=print-radio&utm_term=perdiem&utm_campaign=shortcuts