Working for yourself is full of many perks, but filing taxes isn’t one of them. When tax time comes around, you realize that managing your taxes as a freelancer is a lot more complex than it is for your 9-to-5 colleagues who receive a single W-2 from their employer.
As a freelancer or small business owner, it’s up to you to make sure you correctly report your income, file the right forms, count up your business expenses and have sufficient records in the event you’re audited. But while things can be a lot more complicated, there’s also opportunity: freelancers can write off many of their work-related expenses.
If you’re navigating your expenses as an independent worker this year, here are a few tips to help you out. As with anything you read on the web, none of this should replace the specific advice from a tax advisor who’s familiar with your own situation:
Report your business income on Schedule C with your 1040
Sole proprietors need to file a Schedule C with their personal income return. This tells the IRS if your business made a profit or loss for the year. On line 1 ("Gross receipts or sales"), you’ll need to report all income you made throughout the tax year.
Your income should include all the amounts reported on 1099 forms issued by your clients, but also any other income you may have made as well. Always be sure to double check each 1099 you receive: your clients aren’t impervious to error and they could accidentally over-report the amount they paid you for the tax year.
Tip: Sole proprietors and many single member LLCs will be reporting their business income using a Schedule C and 1040. If your business is structured as a partnership, you’ll need to file Form 1065; C Corporations use Form 1120; and S Corporations use 1120s.
Deduct 'ordinary and necessary' business expenses
The IRS says that you can deduct any business expenses that are “ordinary and necessary.” For the most part, these are reported on your Schedule C. Check out IRS Publication 535 for all the rules and regulations surrounding allowable expenses.
For example, you can write off the cost of any equipment and supplies you purchased for the business, such as a computer, printer, office furniture and work supplies like paper and envelopes. If you purchased a new laptop that you use partly for business and partly for personal, you can deduct a percentage of the laptop cost based on how much it was used for your business.
Medical insurance can be a significant expense for many. “A lot of people don’t realize that if you are self-employed, you can take your medical insurance deduction on page one of your tax return. This can amount to a very nice benefit,” advises Linda Dawson, owner of public accounting firm Dawson & Associates.
Mileage and auto expenses
As a freelancer, you’re entitled to deduct some of your car and travel expenses. Keep in mind that commuting is not deductible. (It’s considered “personal.”) If you rent an office somewhere or drive to a coffee shop to work, you cannot deduct this cost. But, you can deduct travel related to meeting with a client, attending a business event, etc.
When calculating your car expenses, you can use either the mileage driven or your actual auto expenses. “If you drive a lot and/or have an older vehicle, mileage may generate a larger tax deduction for you. If you don’t drive much and/or have a newer car, then actual expense will probably be better,” says Dawson. “But calculate your tax return both ways to make sure you are taking the largest deduction available to you,” she advises.
Home office deduction
If you work from home, you might be entitled to a home office deduction. In order to qualify, you need to have a dedicated space in your home that you use exclusively for business and nothing else. Working from your living room couch won’t qualify, but a small office, or partitioned section of a room, does.
The IRS gives you two options for calculating the home office deduction. You can use the simplified method, where you deduct $5 per square foot of office space, with a cap at 300 square feet. Alternatively, you can take the actual cost where you add up your home costs (e.g. rent, mortgage, utilities, some home repair expenses) and then multiply this number by the percentage of your home that’s used as your office.
The best strategy is to calculate your deduction using both methods and see which one gives you the biggest deduction.
Don’t panic if you can’t pay
If you haven’t been withholding a percentage of each client check or paying your quarterly estimated taxes, you may get a nasty surprise at tax time. If you can’t pay what you owe, don’t panic…and definitely don’t ignore the situation. If you don’t file or extend your tax return, you will get hit with failure-to-file penalties and interest on what you owe.
Dawson recommends two courses of action for those who can’t pay.
File your tax return on time and pay what you can. If it looks like you won’t be able to pay the tax bill in full within the next couple of months, then your next step would be to request an installment agreement.
If your tax return won’t be prepared by April 15, then file an extension and pay what you can with the extension. When you file your tax return either pay the balance due or request an installment agreement.
“Regardless of whether you file on April 15 or extend your tax return, pay down as much of your balance due as possible,” says Dawson. “You will be subject to interest at around 3% per year and failure-to-pay penalties of half of 1% for every month that you have not paid your tax.”
Moving forward
If your freelancing business is structured as a sole proprietorship, you will soon realize that you need to pay self employment (your FICA and Medicare) taxes on top of your income taxes. This is because the IRS considers you both as the employer and employee. Many freelancers choose to form an S Corporation, or LLC that is taxed like an S Corporation, in order to reduce these self-employment taxes.
It’s too late to make any changes to impact your tax year 2015 tax return, but you can talk with a tax advisor after tax season is over to reassess your business structure and see if there’s anything you should do differently for next year.
