As a freelancer, you're often busy with your work, finding new clients, and delivering great results. Because you're so focused on your job, you might forget about other important things like saving money on taxes. You probably know that you can save on taxes by writing off costs like office supplies and travel. But there are other, less obvious ways to lower your tax bill as well. Let's look at some of those options you might not know about.
Note: While this guide is based on U.S. tax rules, most countries have very similar tax deductions for freelancers and small businesses. However, it's always a good idea to check with local authorities to make sure these deductions apply to you.
1. Home Office Deductions
Most freelancers are aware they can write off home office expenses. But did you know that this deduction isn't limited to just a desk and a chair? You can also deduct a percentage of your rent or mortgage, utilities, and even home repairs based on the square footage of your home office.
For instance, if you're a freelance writer who works from a dedicated home office, and your home is 1,500 square feet in total, and your office takes up 150 square feet. That means your office accounts for 10% of your home's total square footage.
If your monthly rent is $1,200, you could potentially deduct 10% of that, or $120 per month, as a home office expense. This would add up to $1,440 over the course of a year.
Similarly, if your monthly utility bills (electricity, gas, internet) come to $300, you could deduct 10% of those costs as well, adding another $30 per month or $360 annually to your deductions.
If you had to make a home-wide repair, like fixing the heating system for $500, you could also deduct 10% of the repair cost, or $50.
So, between your rent, utilities, and the occasional home repair, you could accumulate $1,850 in home office deductions for the year, all based on the square footage of your workspace.
2. Educational Expenses
You probably already know that you can write off the cost of courses, workshops, and seminars that are directly related to your freelance work. But did you know that other types of educational materials can also be deductible?
For a more unusual example, let's say you're a freelance video game reviewer, blogger or a content creator who specializes in technology reviews. You could potentially write off not just the cost of video game software but also the equipment used for your work, such as a TV and a PlayStation 5.
In this scenario, if you buy a new 4K TV for $1,200 and a PS5 for $500 to review the latest games and tech features, these could be legitimate business expenses. Similarly, if you purchase games for $60 each to review, those costs could be deductible as well. The key is that these items are somehow related to your freelance work and are used primarily for business purposes. In you are unsure, remember to consult a tax advisor to ensure you're following the rules correctly for your specific situation.
3. Health Insurance Premiums
If you're self-employed and can't get healthcare coverage through a spouse's plan, you can typically deduct the cost of your own health insurance premiums. In some scenarios, you can also deduct the premiums paid for your spouse and dependents.
For example, let's say you're a freelance graphic designer earning $60,000 a year. After other business expenses, your net income is $50,000. You pay $300 a month for your own health insurance and another $200 a month for your spouse's policy. Over a year, that totals to $3,600 for your own coverage and $2,400 for your spouse's. Depending on your specific tax situation, like your net income and other deductions, you could potentially deduct both amounts, totaling $6,000, from your taxable income. However, tax rules can be complex, so it's advisable to consult a tax advisor to fully understand how this deduction applies to your unique circumstances.
4. Self-Employment Tax
Freelancers have to pay self-employment tax, which covers Social Security and Medicare taxes. What many don't realize is that you can deduct half of this self-employment tax when calculating your adjusted gross income.
Imagine you're a freelancer who earned $50,000 in net income for the year. Self-employment tax is approximately 15.3% of your net earnings (12.4% for Social Security and 2.9% for Medicare). In this scenario, you'd owe $7,650 in self-employment tax ($50,000 x 15.3%).
However, the IRS allows you to deduct half of this amount, or $3,825, from your taxable income when calculating your adjusted gross income (AGI). This means your AGI would be reduced to $46,175 ($50,000 - $3,825).
If you're in a 22% tax bracket, this reduction in AGI could translate into additional tax savings of $841.50 ($3,825 x 22%).
So, in this example, not only are you responsible for your self-employment tax, but you also get to reduce your income tax by $841.50 thanks to the self-employment tax deduction.
5. Client Entertainment
While the rules have tightened up, you can still deduct 50% of the cost for meals and entertainment that are directly related to your freelance business, as long as the expense is reasonable and not lavish.
Most likely scenario for a freelancer is that you're meeting with a potential client who is interested in hiring you for a long-term project. You decide to go for a business lunch to discuss project details and build rapport. The total bill for the meal comes to $60. According to IRS rules, you can deduct 50% of client meal and entertainment expenses as long as they are directly related to your business and are not lavish or extravagant. In this case, a $60 meal at a mid-range restaurant could be considered reasonable.
So, you would be eligible to deduct 50% of the $60, which amounts to $30, from your taxable income. This deduction can be valuable when you consider that you may have multiple client meetings over the course of the year.
Just remember to keep a record of the meeting and the receipt for your meal. Note the client's name, the business purpose of the meal, and the restaurant's name and location. This way, you can substantiate your expense should you ever need to. If you are using a receipt scanner or expense tracker app, it is easy to write these down in the expense details so you will remember them down the line.
6. Business Insurance
Business insurance premiums are usually deductible. This includes not only general liability but also professional liability insurance, and in some cases, even a portion of your auto insurance if you use your vehicle for business.
Let's consider you to be a freelance event planner. You drive 15,000 miles in total during the tax year. Out of these, you drive 3,000 miles for business meetings, site visits, and errands specifically related to your freelance event planning activities.
To find out what portion of your auto insurance is deductible, you'd first calculate the percentage of business use. In this example, that would be (3,000 business miles / 15,000 total miles) * 100 = 20%.
If your annual auto insurance premium is $1,200, then you could potentially deduct 20% of that cost as a business expense. That comes out to $240 ($1,200 x 0.20).
Remember, the key to utilizing this deduction is keeping detailed records. Log your miles driven for business and personal use, and keep all receipts and invoices related to your auto insurance and other vehicle costs. Using a dedicated receipt scanner and organizer meant for freelancers and small businesses will help you.
7. Internet and Phone Expenses
If you're using your phone and internet for both personal and business activities, you don't have to miss out on potential tax savings. A portion of those bills can be written off as business expenses, based on how much you use them for work. For example, let's say your monthly phone bill is $100 and you estimate that around 50% of your phone usage is for business calls, emails, and app use related to your freelancing. In this case, you could potentially deduct $50 each month, or $600 annually, as a business expense on your tax return. Similarly, if your monthly internet bill is $60 and you use it 70% for business purposes, you could deduct $42 per month or $504 annually.
An alternative approach is to have a separate phone and internet plan exclusively for business use. In that scenario, you could deduct 100% of those bills since they are solely for business activities. That is however not a recommended approach for most freelancers, since the cost of a secondary phone and phone bill will quickly add up.
Whether you opt for partial or full deductions, it's required to maintain records showing the business use of these services. Actually logging detailed records can be a bit difficult, since personal and business use of a phone or internet plan might be impossible to totally distinguish. So what you can do is estimate by time. Let's come up with an example. If you work for 8 hours a day or 40 hours a week, and your total waking hours are 15 * 7 = 105 hours a week, then you could argue that you use your phone and internet for business at least 38% of your time.
8. A New Phone for Both Personal and Business Use
If you want to purchase a new phone for work that will also become your primary personal phone, you can deduct a percentage of it as well. The tax deduction process has luckily been simplified since 2011. Back then cell phones required detailed call-by-call logs for tax deductions, but the current rules only require you to estimate the percentage of business use. This is similar to how portions of your monthly phone bill can be deducted like described in the previous paragraph.
Additionally, the de minimis safe harbor rule allows for the immediate deduction of business equipment costing less than $2,500, including nearly all cell phones on the market. This eliminates the need for calculating depreciation over multiple years. However, it's important to note that this election must be made annually during the tax filing process.
9. Unpaid Invoices
Dealing with unpaid invoices is a frustrating experience that many freelancers unfortunately have to face. If you're a freelance consultant and find yourself with invoices that remain unpaid despite your best efforts to collect, there's a silver lining: you may be eligible to write off these bad debts on your tax return.
Essentially, if you've provided services and billed your client but haven't received payment, the unpaid amount becomes a "bad debt," which is often deductible. This helps to offset some of the financial loss you've incurred. However, it's important to show that you've made reasonable attempts to collect the debt, such as sending multiple reminders or even hiring a collection agency.
Understanding tax deductions is of utmost importance for freelancers aiming for maximizing their take-home pay. These lesser-known deductions are just the tip of the iceberg; there may be many more applicable to your specific situation. Receipt scanner and expense tracker apps like SparkReceipt can help you scan and track all your business expenses, making it easier to claim all the deductions you qualify for when tax time rolls around. Don't miss out on these opportunities to save; your future self will thank you.