As freelancers and consultants, we handle our business operations largely on our own — and tax filing for many of us is no exception. Freelance taxes and tax write offs are not especially thrilling topics for most solos, but understanding the intricacies and policies that surround these items is pretty integral to mastering the self-employed lifestyle — and not giving yourself an annual panic attack!
We assembled this guide to help new and veteran independent contractors properly manage their tax duties and avoid the major pitfalls that often burden 1099-ers throughout the tax preparation process.
Whether you’re planning to file your taxes on your own, or work with a tax professional (which we highly recommend), the points below will give you a clear understanding of your obligations and how to best handle them.
Freelance taxes — a little different from the other side
You need to understand a few important points about your current tax situation — especially if you’ve recently transitioned from the standard 9-5. One of the most immediate changes you will notice in your freelance tax responsibilities is that you now have what is called a “self-employment tax.” This accounts for both your social security and medicare taxes — which would have been withheld from your regular paychecks in an “employed” office job.
Nothing new or crazy there, but the major difference now is that the portion of these taxes that employers are required to cover currently falls on your shoulders. The 7.65% that would have been your share to pay is now doubled to 15.3%.
Did this come as a rude awakening? Then look critically at your pricing structure going forward. From the get-go your project/hourly rate needs to be about 30% higher than it would have been in a traditional work setting to compensate for the added tax burden you now face as an independent contractor (amongst other reasons). For tips on securing this higher figure, check out our post on negotiating freelance rates.
Did you remember to pay your quarterly estimated taxes?
As independents, we find ourselves a little more preoccupied with our civic responsibilities than our W-2 peers. This in part is due to the estimated tax, which is the freelancer’s equivalent of income tax.
Estimated taxes are how independent contractors give the IRS a steady stream of tax revenue, as standard employers would account for, again, via employee withholdings. In the case people generating 1099 income, the government prefers not to receive our full tax payouts in one end-of-year lump sum and can actually penalize us for not managing them on a quarterly basis. You can find the deadlines for 2017’s quarterly estimated taxes in the table below:
I recommend estimating an appropriate quarterly number with your accountant based on your earnings from the prior year (or what you should have paid by the quarter last year). You submit these payments via the 1040 form.
You can dodge the underpayment penalty if: you owe less than $1000 from your freelance work (excluding withholdings and estimated tax payments) or have paid 90% of what you owe for the current calendar year, or 100% of what you owed on the prior year’s tax return (whichever is smaller).
Pro Tip: Make doubly sure that you get your first estimated tax payment in on tax day (April 18th)! This will get you on track for 2017 and minimize the chances of you paying a 3% penalty for the last year.
Rigorously track your 1099 income & expenses
When it comes to managing tax duties for freelancers many clients can be a little … how should we say this … “lax.” Don’t let laissez-faire tax compliance jeopardize your bank account and mental health. And do not just assume your clients got everything right — you can be held accountable for their errors.
Every receipt, every check, every client 1099 and beyond: hang on to them and keep them well organized!
It also helps to open a separate checking account specifically for your freelance deposits and expenses to keep these transactions very neatly documented.
Pro Tip: Receipt scanning apps have gained a lot of popularity with freelancers, and while there are some great tools out there specifically for this purpose, you can save yourself a little cash and log your receipts for free in Evernote using the camera function in the mobile app.
You may also like: How to Not Screw Up: Essential Lifehacks for Freelancers
Independent contractor tax deductions
If you don’t already, think of your freelance business as a magical item. This magical item has a very special power — it can turn anything it touches into a tax deduction. Pretty cool trick, huh? Let’s see how it’s done.
Solo businesses may not have all of the same trappings as their small business and corporate peers. However, you still need your workspace to serve the core functions of an office — you need a good chair to work in, you need an up-to-date computer, and it would be pretty nice if the lights turned on . . . these are all potential tax deductions!
• Office supplies
• A coffee machine
• The approximated electricity used to power your work space*
*These items are contingent upon you sufficiently proving that you have a space in your house or apartment that is dedicated solely to work-related activities. The multipurpose “dining room office” doesn’t count!
You also have expenses that are unique to your profession — be it consulting, engineering, design, writing or any art form. Susan Lee of Freelance Taxation wrote up an incredibly useful guide that outlines potential tax deductibles specific to several distinct freelance fields.
Is health insurance tax deductible?
While it would be a bit of a stretch to call your health an “operating expense,” (it’s certainly a bad pun . . .) it doesn’t matter — your health insurance premiums are 100% tax deductible!
Even non-ACA plans from independent or short-term coverage providers are still deductible as medical expenses (although they don’t currently preclude you from the individual mandate tax).
Take a look at our expert guide, if you’re still figuring out what to do for freelance health insurance coverage after open enrollment.
Continued Education Tax Deductions
Continuing to grow your skills is a good thing, right? Fortunately, independent contractors and employees alike have the ability to write off substantial expenses that accompany continued education. These items include:
• Tuition costs
• Costs of educational materials (textbooks and software)
• Online education
• Any form of learning that improves your skills within your current profession
• Any educational opportunity that is necessary for advancement in your current position
• Any work training you are required to pay for
However, there are a few little nuances here. You might have thought to yourself: “what about student loans?” The interest you pay is not tax deductible, unfortunately. However, you qualify for a deduction by paying back a student loan. You can learn more about this on the IRS page for this topic.
While all kinds of personal enrichment are great, there are also limitations to their tax deductibility. Any education that qualifies you for a new career is not considered a qualified expense (i.e. going to law school, getting an MBA).
If you decide after reading this article that your true calling is to become architect and that you also want to learn how to speak Italian — Godspeed! But you will not be able to deduct the education necessary for your new career horizon or peripheral interest.
Travel Expense Tax Deductions
Sometimes you have to actually get out of your house and mingle with the outside world. It’s okay, though, because your magic item still works away from home. Any gas, bus, train or even plane expenses that are necessary in order to conduct your self-employed business matters are all fair game, as is the lodging (provided that you were good and documented everything as we said above).
Your dining is covered too, but with further qualification. You can deduct 50% of your meal expenses that were used to entertain clients and 100% of your food expenses for employees (if you have them). Going out for your daily coffee shop chai will not stick, unfortunately.
What about expat taxes?
While we’re on the topic of travel, let’s talk expat taxes. You’re working abroad — you’re loving life — you’re free of that frustrating U.S. tax burden . . . right? NOPE.
While you don’t need to worry about the ACA’s individual mandate and have a nice built-in extension until the second quarter (June 15th) to file, there is no getting around the U.S. self-employment tax.
However, granted that you qualified for resident status abroad, you can deduct your housing expenses if they amount to over 16% of your foreign earned income. And speaking of foreign earned income, you can also exclude the first $101,300 you make abroad from your tax reporting (whether from a U.S. company or not). This is reported via the 2555 form.
It’s important to remember, though, that this is only your freelance tax obligation for the United States — you still have to settle up your finances in the country you reside in as well. While many territories have agreements in place to prevent “double jeopardy” situations for expats, you will need to be vigilant in researching the tax policies in your country of residence.
And if you have a foreign bank account with 0ver $10,000 in it — you’d better let the IRS know.
HELP! I need to file an extension!
Behind on your accounting? Waiting on a big client to give you a 1099? If for whatever reason it doesn’t look like you’ll be able to file by April 18th, now is the time to act. Pull up form 4868, fill it out, and get it over to the IRS by April 18th for a six-month extension.
Sounds great, huh? Well, if you really don’t need an extension, I wouldn’t recommend going this route. As solos, there will never be a convenient time to file freelance taxes — you’re really just kicking the bucket down the road in this scenario. If you have the information you need to file on time, do it, and save yourself the stress later on.
Note: It’s important to understand that this is not an extension on paying the taxes you currently owe — you are just extending the time you have to produce your documentation of 1099 income. You still need to pay your estimated income taxes on time. If you overpay, it will be evened out on your tax return.
Work with a tax professional (really . . .)
Above all, you should work with a professional accountant. I know … I know. Another expense — yikes. Fortunately, accountants usually scale fees to the size of a client’s business, and expenses towards filing your freelance taxes are in themselves tax-deductible! Had to catch a break somewhere!
Software like Turbotax and commercial chains like H&R Block are very tempting, but risky. You really need to know what you’re doing when using them and it can be very limiting working with a commercial tax preparer who does not understand the full ins and outs of your craft (potentially meaning less money back from your tax return). Save yourself time and anxiety and get your compliance done the right way the first time.
You can find qualified tax preparers right in your backyard with this search feature.
Make your life easy
If you found yourself muttering “ahhh sh#1!!” while reading this guide, I can assure you that you aren’t alone. Fortunately there is still time to organize your 1099 income and tax write offs — and find the right professional to help you take care of it all.
Managing freelance taxes can be . . . taxing, but it’s also a very educational experience.
You’ve probably noticed some big ways you made your life a little more stressful than it needed to be on the tax front (myself very much included here). If you’re facing underpayment fees, a mountain of last-minute paperwork, or general disorganization, you know that you need to change your process for the next year and you have the opportunity to do this now for 2017.
Pro Tips: If you aren’t already: start proactively planning your quarterly payments and rigorously documenting your business expenses. Also set some clear expectations with your clients for what they need to do to make your tax reporting as easy as possible. There’s no reason to continue doing this the hard way.