The benefits of being a freelancer are incredibly rewarding. But tax time is a different story. For freelancers and independent workers, tax season can present a number of challenges. In that spirit, we’ve put together a 5-tip cheat sheet to help you prepare for the fast-approaching April 15th deadline.
1) Be vigilant about tracking your incomes and expenses
As a freelancer, you have to be your own payroll department. You also tend to be at higher risk for audits. Be vigilant about recording how much you make and spend throughout the course of the year. Keep track of all of your income, including paid invoices and contracts. Set up a separate banking account for business and personal use. It also helps to have separate PayPal, credit card, internet, and phone accounts.
Keep detailed documentation of your business expenses. Save all of your receipts. Try categorizing your expenses by the same categories on your Schedule C form: advertising, insurance, credit card/loan interest, office expenses, legal/professional services, office expenses, home office rent/lease, office supplies, repair and maintenance, utilities, travel, meals and entertainment, other expenses. Don’t forget you can claim a deduction for financial software or cloud accounting platforms to help streamline your record keeping.
2) Set aside money for tax payments and an emergency fund
Not only do freelancers need to pay lump-sum quarterly taxes, but they also need larger emergency funds than employees with regular paychecks. Be proactive and avoid the stressful scramble to make your quarterly payments. Set aside money towards your tax payments, at least quarterly or even better monthly. Try keeping a separate bank account to save for your tax payments. According to John Hewitt, Founder of Liberty Tax Services, it’s recommended to set aside 25 to 35 percent of your income for Federal, state and self-employment taxes.
As a freelancer, your income can vary from year to year or even quarter to quarter. Take a look at your previous tax returns as a rough guide to anticipate your payments. Ideally, you should also keep an emergency fund of six to twelve months of expenses, especially if you’re supporting a family.
3) Claim your home office deduction
It’s a myth that claiming your home office always red flags an IRS audit. If you legitimately work from home and have an office space dedicated exclusively for work, don’t be afraid to claim the home office deduction, as long as you follow IRS guidelines.
If your home office is used “regularly and exclusively for work,” you can deduct a percentage of your rent or mortgage interest, homeowner’s insurance, utility bills, home repair costs, and depreciation. The percentage is based on how much of your home you use as an office.
Since the beginning of last year, calculating your deduction is simpler than ever. Instead of complicated record keeping and forms, you can use the new “safe harbor” deduction which is capped at $1,500. The new form simplifies the process, by letting you deduct $5 per square foot for your office up to 300 square feet. If your office is bigger or you regularly deduct more than $1,500, you can still use the longer form.
4) Deduct your health care insurance premiums
As a freelancer, you can deduct your health care insurance premiums (without the need for itemization) for yourself, spouse, and dependents. The Health Savings Account allows you to deposit thousands tax-free, to pay for out-of-pocket medical expenses throughout the year. If you qualify for Medicare, you can deduct your premiums for Medicare Part B and Medicare Part D, plus the cost of supplemental Medicare policies or the cost of a Medicare Advantage plan. The only caveat is that you can’t be eligible for coverage under an employer-subsidized health plan through your employer or your spouse’s employer.
This tax season, whether you have health insurance or not, you will be required to report your healthcare insurance coverage. You’ll need to declare your health insurance payments on form 1095 to determine if you qualify for the Premium Tax Credit (PTC) or if you owe money from overpayments of the PTC (Form 8962). If you still don’t have health insurance, you will have to pay Affordable Care Act fines, depending on your income and number of household members.
5) Tax shelter your income
This tax year, the maximums were raised for IRA contributions, personal exemptions, and contributions to health insurance. One of the best ways to lower your taxes is to stash away money in a tax-deferred retirement plan. The money you contribute to Individual Retirement Accounts (IRA) will not only help you build your retirement fund, but will also be deducted from your gross income, thereby reducing your taxable income.
This year, you can contribute up to 25 percent of your net earnings from self-employment, up to $52,000 to a Simplified Employee Pension (SEP) IRA or self-employed 401K, (plus up to $17,500 in deferred salary, or if you’re over 50, up to $23,000). If you’re a sole proprietor, you can also contribute up to $12,000 to a SIMPLE IRA.
Follow these 5 basic tips to help simplify the tax process and save yourself some well-deserved time and money. Your business depends on maximizing your resources, so don’t miss any special business deductions for which you qualify as a freelancer. You may also want to consult a professional and take advantage of your tax services deduction. Happy tax season and best of luck on maximizing your return!