Filing your taxes as a self-employed freelancer might be a little confusing at first. But, once you get the hang of things, you’ll realize that it isn’t so bad because you can take advantage of some helpful deductions. Whether you’re working full-time or part-time, there are lots of ways that you can save on taxes when you’re working for yourself.
What are some of the top tips from pros that can help you save big on your taxes as a freelancer? We’ve compiled a list of six smart strategies below, listed in order from least to most effective for tax savings.
Please keep in mind that, while we’ve made every effort to ensure this information is up-to-date and accurate, it doesn’t constitute legal or tax advice, and it shouldn’t be considered a substitute for legal or tax advice. When in doubt, always seek professional guidance from an attorney or tax expert.
- Establish a health savings account
- Time year-end income and expenses
- Establish a retirement account
- Track and deduct business expenses
- Take the pass-through deduction
- Convert to S Corporation taxation
- Now you’re ready to save big on taxes!
Establish a health savings account
First up is establishing a health savings account, also known as an HSA. It’s like a medical IRA, so if you get sick, it’ll help cover your medical expenses. What if you never get sick? Well, it’s still great to have because it can give you great tax benefits.
To establish an HSA account, you’ll need to go to a bank or other financial institution. Don’t worry, as it’s easy to find one that will happily open an account for you. Just keep in mind that you must also obtain a high-deductible health insurance plan—those plans will feature lower premiums than those with lower deductibles.
How can an HSA help you when tax time rolls around?
- You may deduct your annual HSA contributions from your income taxes every year, up to the annual dollar limits listed below.
- Any income that the money in your HSA earns will be tax-free.
- If you make withdrawals in order to pay for health related expenses, they’ll be tax-free. On the other hand, withdrawals for nonmedical expenses will be taxed and penalized.
- Once you reach the age of 65, or if you become disabled, you can withdraw your funds from your HSA for any reason without penalty. And if you use the money for nonmedical expenses, you’ll only have to pay regular income tax on those withdrawals.
The other nice thing about an HSA is the fact that the money you put into it is yours forever.
So, how much can you contribute to your account every year? Well, there’s no minimum amount that you’re required to contribute annually, which means you can contribute nothing at all if you want. But if you have individual coverage, the max you may contribute to your HSA for 2019 is $3,500. And if you have family coverage, the max you may contribute is $7,000. Also, if you’re over 50, you can add $1,000 to your annual HSA contribution.
Time year-end income and expenses
Virtually all freelancers use the calendar year as their tax year, and they’re cash basis taxpayers.
Wait, what does cash basis even mean? It means you count money as income only in the year you receive it. And you deduct an expense in the year that you paid for it. Why does this matter? Because it lets you do some clever tax planning at the end of the year.
Want to minimize your taxes for the year? Who doesn’t, right? Well, you could defer income and speed up paying deductible expenses.
You can defer income by refraining from billing clients until the following year. Keep in mind that you can’t avoid having taxable income by simply not cashing a check until the following year. Under a legal doctrine known as constructive receipt, you must count as income any money or property made available without restriction during the year. Therefore, a check counts as income when you receive it, not when you cash it.
You can also opt to increase your deductible expenses for the year by buying things for your business prior to the end of the year. The best part is that you don’t even have to pay cash for it by December 31 in order to take advantage of this deduction, as you can certainly use your credit card and still deduct the full amount of the expense.
Establish a retirement account
Another wise way to save on taxes is by establishing and funding a retirement account. Why, you ask? It’s simple: you can deduct the amount that you contribute to a tax-qualified retirement account from your income taxes.
Side note: This doesn’t apply to a Roth IRA or Roth 401(k).
On top of that, you don’t have to pay taxes on investment earnings from retirement accounts until you withdraw the funds. Just remember: early withdrawals before you’re 59½ years old are subject to a 10% penalty.
The great thing about this strategy is that it’s easy to establish a retirement plan with a bank, mutual fund, or other financial institution. With these accounts, you don’t have to make contributions every year, and your contributions can vary from one year to the next. Plus, you can invest your money in almost anything (mutual funds, stocks, bonds, and notes).
There are a few different types of retirement accounts available to freelancers just like you. These include:
- Traditional IRA: This can be established for any individual. For 2019, you can contribute up to $6,000 and deduct the full amount if you and your spouse have no other workplace retirement plan. Sweet!
- Individual 401(k): This is ideal for most freelancers because it lets you contribute a lot. For 2019, you can contribute 20% of your net profit from self-employment, plus an elective deferral contribution of up to $19,000. And the maximum contribution for 2019 is $56,000. See what we mean? It’s a lot!
- Simplified Employee Pension (SEP) IRA: This allows you to contribute up to 20% of your net profit from self-employment annually, up to a max of $54,000 for the year 2019. Just another great option to consider.
Note: Rather than establishing a regular IRA or a 401(k), you can consider opening a Roth IRA or Roth 401(k). However, with these, you get no deduction for your contribution. The perk, though, is that you don’t have to pay any tax on withdrawals that are made after the age of 59½. Also, if you’re age 50 or over, you can make additional tax-deductible catch up contributions to these accounts. For IRAs, you can put in an extra $1,000, while for a 401(k), you can put another $6,000 in.
Track and deduct business expenses
As a freelancer, you can deduct almost anything that you buy for your business, as long as it’s necessary and the cost is reasonable.
Below are some of the most common business expenses for freelancers:
Spending money on things you need for your office is considered a deductible expense. As an example, you might deduct your utilities and rent. Work from home? Then you might be able to deduct the cost of your home office—this is especially valuable if you rent because it lets you deduct a portion of your monthly rent, which can be a sizable expense that’s ordinarily not deductible!
Advertising and marketing expenses
Spending money to promote yourself and your business? It’s a deductible expense! For example, this category would include the cost of having your website designed and maintained, and it would also include hosting fees for your site, the cost of getting a domain name, and the cost of having someone help you with your resume. You could even deduct the cost of brochures, business cards, listings in directories, and more.
Keep track of the costs associated with any driving that you do for business. The only important exception here is the cost of commuting (to clarify, nondeductible commuting is when you drive from your home to a place of business). The rest is tax deductible, and there are two ways to figure out this deduction. First, you can keep track of all of your car expenses, such as gas and repairs, and deduct the business percentage. If you’d rather not keep track of how much you spend on gas, oil, repairs, car washes, etc., you can instead use the standard mileage rate. When you use the standard rate, you only need to track how many miles you drive for business, not how much you spend on the car. For 2019, the standard mileage rate is 54.5 cents per mile. Either way, you have to track your business mileage—thankfully, there are a lot of smartphone apps that make this a lot easier than it used to be.
Don’t forget to deduct expenses that you incur when you go out of town for your freelance business. These travel expenses could include airfare or other transportation costs, as well as hotel and other lodging costs. Note: You may only deduct 50% of the cost of meals when you travel on business.
You get a deduction whenever you purchase tangible personal property that lasts more than one year. Examples include office furniture, computers, and even business-related books. Nice, right? The full cost of this property can usually be deducted in a single year using 100% bonus depreciation (in effect through 2022), Section 179 expensing, or the de minimis safe harbor (applicable to property that costs $2,500 or less).
Legal and professional services
Have you paid attorneys, accountants, consultants, or other pros for work related to your freelance business? Then you can go ahead and deduct those fees as well. Simple and straightforward, and a nice way to save on taxes when you’re self-employed.
Any insurance that you buy is deductible. For example, business liability insurance, or insurance for business property, can be deducted from your taxes. Plus, if you have a home office, you may deduct a portion of your homeowner’s insurance, too. And self-employed individuals are even allowed to deduct 100% of their health insurance premiums from their income taxes (this is a special personal deduction, not a business deduction).
Take the pass-through deduction
Thanks to the Tax Cuts and Jobs Act, which established a brand new deduction, owners of all of these types of businesses can deduct from their income tax up to 20% of their net income from the business. This is referred to as the pass-through deduction.
To clarify, if you earned $100,000 in profit from your freelance business, and you qualify for the pass-through deduction, you may deduct up to $20,000.
It’s more complicated if your taxable income is over $157,500 if you’re single or $315,000 if you’re married and filing jointly. In those cases, your deduction is based wholly or partly on how much you pay your employees and/or the cost of the property you use in your business. If you have no employees and little or no expensive business property, your deduction will be quite small.
Also, business owners who perform certain types of services aren’t entitled to take the pass-through deduction at all if their taxable income exceeds $207,500 if single or $415,000 if married filing jointly. Those services include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, and trading and dealing in securities or commodities.
This handy deduction took effect on January 1, 2018 and is scheduled to last through December 31, 2025. Be sure to take advantage of it while you can!
Convert to S corporation taxation
The best strategy for freelancer tax savings is…drum roll, please…converting to S corporation taxation!
Think of this as the freelancer’s nuclear option. By changing into an S corporation, you can free yourself from much of your self-employment tax burden. And that’s important, as self-employment taxes consist of the 12.4% Social Security tax and 2.9% Medicare tax, for a total combined tax of 15.3% up to the Social Security tax ceiling ($132,900 in 2019).
For many lower income freelancers, self-employment taxes exceed their income taxes, and these taxes are their largest single business expense. Ouch!
But, even for higher income freelancers, self-employment taxes are a significant burden. So, no matter what you earn, when you convert to S corp taxation, you completely change your tax life. That’s because you’ll become an employee of your business, which means you won’t be self-employed anymore. Instead, your business will pay you wages and benefits as its employee.
This also means that, as an S corp, you and your business must pay employment taxes (Social Security and Medicare taxes) on your employee wages. You and your business each pay half of these taxes, with the tax being the same at 15.3% up to the Social Security income ceiling.
And here’s where S corporation taxation is super helpful: employment taxes need not be paid on distributions paid to you as a shareholder—that is, on earnings and profits that pass through the business to you as a shareholder, not as an employee in compensation for services. Therefore, the more your business pays you as a shareholder distribution, the less employment tax you and your business will have to pay. You do, however, still have to pay income taxes on your distribution.
This chart displays how much Social Security and Medicare tax you can save with S corporation taxation when you take 40% of your business profit as employee salary and 60% as a shareholder distribution:
|Business Income||Social Security/Medicare Tax Savings with S Corp. |
What if you took no salary at all? You wouldn’t owe any employment taxes in that case. But, as you’d expect, this isn’t allowed, as the IRS requires that S corp shareholder-employees pay themselves a reasonable salary that’s at least what other businesses pay for similar services.
Need more info on how to establish your salary while running an S corporation? Check out our Freelancer’s Guide to Paying Yourself a Salary From an S Corporation.
Want to convert your business to an S corporation? You’ll have to form either a corporation or limited liability company (LLC) first, and you’ll do this in the state where your office is located. Then you’ll obtain S corporation tax treatment by filing IRS Form 2553, Election by a Small Business Corporation.
Pro tip: To make the process of transforming your sole proprietorship into an S corporation even easier, you can enlist the help of Hyke. This service will assist you in establishing your S corporation, and help you file all the right paperwork on time in order to maintain your status long into the future. On top of that, you’ll receive expert guidance from professionals in finance, accounting, and taxes so that you can rest assured you’re running your business like a pro and saving the most money possible come tax time.
Now you’re ready to save big on taxes!
What smart business owner doesn’t love saving their hard-earned cash? With the tips above, which are surprisingly easy to implement, you can start taking steps daily to reduce your tax burden and save money when it comes to paying your taxes.
About the authors
Stephen Fishman writes for Hyke and is an attorney and author who writes useful and recognized guides on taxes and business law for freelancers. He is the author of over 20 books and hundreds of articles.
Ugur Kaner is the co-founder and CEO of Hyke, the online platform that helps freelancers save $15,000 or more in taxes every year