Top 10 Tax Tips for Freelancers and Contract Employees

One of the perks of freelancing or working as an independent contractor is the ability to claim deductions without needing to itemize your entire tax bill.

In truth, who enjoys dealing with taxes? The beauty of freelancing lies in the freedom to ditch the formal attire, with your snarkiest colleague being your feline friend, Mr. Ribbons, and indulging in leftover cake from the fridge for lunch without judgment. However, it’s also worth noting the advantage of being able to deduct certain expenses as legitimate business costs.

Let’s explore several tips to assist independent contractors and the self-employed in obtaining some tax relief. To kick things off, it’s crucial to ascertain whether you indeed qualify as a freelancer in the first place.

In the language of the IRS, engaging in work for a client or company as a non-employee—whether it’s freelance or contract work—qualifies you as an “independent contractor.” It’s crucial to understand your classification as an independent contractor to avoid inadvertently running afoul of IRS regulations.

The guidelines are straightforward: If you receive payments exceeding $600 from any individual client, they are required to report it to the IRS. If you’re not an employee of the company, such income falls under self-employment, prompting the IRS to scrutinize your tax return for accurate reporting.

Even if you hold a full-time position elsewhere and engage in freelance work on the side, you’re not exempt. Any self-employed earnings exceeding $400 must be reported to the IRS.

Seems straightforward, doesn’t it? Surprisingly, many independent contractors lack a structured system for managing their income, expenses, deductions, and estimated taxes (we’ll delve into that tax tidbit shortly).

While traditional paper receipts for business expenses may seem reliable, they’re not always the optimal solution. They’re prone to getting misplaced, and even minor issues like faded ink can jeopardize your ability to substantiate purchases in the event of an audit. Consider investing in a scanner to swiftly upload images of your receipts or bills. This way, you’ll have both physical and digital copies for your records. Moreover, maintaining an organized system for tracking and retrieving your income and expenses is crucial. Such records can help identify any missing payments from clients, ensuring you don’t overlook any earned income.

Unsure about distinguishing expenses from assets? It might be beneficial to brush up on some bookkeeping fundamentals. If you’re hesitant to enroll in accounting classes at your local community college, consider opting for financial software as a convenient alternative.

Having a digital accounting system at your disposal offers numerous advantages beyond tax-related matters. For instance, you can effortlessly manage invoices and billing, and even generate reports on your financials to aid in marketing or sales efforts.

However, the primary advantage during tax season is the ability to access a well-organized, efficient record of your income and expenses. Some software programs even allow you to e-file certain tax documents directly from the platform. Additionally, in the event of an audit, detailed records will be required by the IRS. A robust bookkeeping system could potentially spare you considerable stress in the event of an IRS audit.

While we’ll explore some of the most beneficial deductions shortly, the overarching advice is crucial: Familiarize yourself with available deductions and don’t hesitate to claim those applicable to your situation. Self-employed individuals have the added advantage of being able to claim additional deductions above the line, allowing them to benefit from the standard deduction while also deducting additional expenses as business-related costs. These are categorized as “business expenses” rather than miscellaneous deductions.

If you’re working across multiple states, be sure to check our article on paying income tax in multiple states and maximizing your potential refund. Did you know you might qualify for job search tax deductions simply by seeking a new job?

It’s worth noting that you have the option to either take a standardized, flat deduction or itemize all your deductions based on your expenses. While for most individuals, opting for the standard deduction is simpler, if you have significant expenses, itemizing could potentially save you money. However, it’s essential to surpass two percent of your adjusted gross income before you can begin claiming deductions. Conduct thorough research to determine the approach that best suits your circumstances.

One of the most coveted deductions for self-employed individuals is the home office deduction. Unlike employees with full-time positions, self-employed workers can claim this deduction, along with its associated direct and indirect expenses, without the need for itemization. Essentially, you can still benefit from the standard deduction while also deducting the costs related to your home office.

However, it’s not as if the IRS will allow you to designate just any corner of your home as a home office. There are stringent criteria you must meet. Firstly, your office space must be primarily and consistently used exclusively for your business activities. (You can forget about attempting to claim the top of your air hockey table in the children’s playroom as a legitimate workspace.)

Fortunately, qualifying for the deduction has become more straightforward. Previously, you had to calculate the business percentage of all home office expenses, including bills and utilities, to determine the appropriate deduction. Now, you can simply multiply the square footage of your home office by $5 (for a deduction of up to $1,500) for a much simpler deduction method. Unless your office is exceptionally large or your expenses exceed $1,500, it’s advisable to opt for the simplified method for ease of calculation.

For self-employed independent contractors, it’s important to note that you can deduct any business travel expenses incurred during overnight trips away from your tax home (the location where you conduct your business). If your entire trip is business-related, you’re eligible to deduct the entire expense. However, if your trip includes a mix of business and personal activities, you must keep track of the business-related portion and only deduct that amount. For instance, stopping by your parents’ house to treat them to dinner at Applebee’s after a business trip wouldn’t qualify for deduction.

Additionally, you can deduct meal expenses incurred during business-related travel or for business-related entertainment. While this may sound appealing, it’s essential to remember that you can generally only deduct up to 50 percent of the meal’s cost, and the IRS scrutinizes expenses for any “lavish or extravagant” claims. Alternatively, you can utilize the standard meal allowance if you haven’t kept track of the actual meal expenses. Each state establishes a per diem amount, which serves as a convenient method for deducting business meal expenses.

Thus far, we’ve covered the brighter side of tax tips. Remember to capitalize on that valuable home office deduction and invest in some nifty software! However, now we delve into the more somber aspect of filing as an independent contractor: estimated taxes.

As a self-employed individual, your paycheck doesn’t come with taxes withheld by an employer. Consequently, you bear the sole responsibility of setting aside a portion of each payment for Uncle Sam. There isn’t a universal flat rate for freelancers to set aside, as state taxes vary significantly. It’s advisable to consult with an accountant in your state to ensure you’re on the right track.

Moreover, if you’re turning a profit—meaning you’re earning more than $400 a year—you’re also required to submit quarterly tax payments. The IRS expects payments throughout the year, not just at tax season’s end. To accommodate this, four quarterly payment due dates have been designated throughout the year, though you have the flexibility to make payments more frequently if that’s more convenient for you.

Enough of the gloomy talk! Here’s some more uplifting news: As an independent contractor, you have the benefit of deducting all your health insurance premiums without the need for itemization. (This means you can make an above-the-line adjustment, effectively reducing your entire adjusted gross income.) What’s more, you’re also eligible to deduct the health insurance premiums for your spouse and dependents.

But here’s a clever strategy: If you’re keen on reducing your taxes as a self-employed individual, consider hiring your spouse. By providing your significant other with health insurance as an employee, you can deduct the cost of their insurance from your self-employment income and tax liability, as long as you’re included on the plan.

Another challenge of freelancing? You lack the convenience of an employer setting up a retirement plan for you, and you’re solely responsible for contributing to any retirement fund. Essentially, you must diligently set aside a portion of your income for your golden years.

However, this doesn’t mean you won’t reap any benefits during tax season. As a self-employed individual, you have the opportunity to contribute up to 25 percent of your net earnings from self-employment—capped at $52,000 in 2014—to a Simplified Employee Pension (SEP) IRA. Additionally, if you’re a sole proprietor, you can contribute up to $12,000 to a SIMPLE IRA. These contributions offer above-the-line deductions, and certain other IRA accounts may also qualify for deductions up to a specified amount.

Alright, if you’ve held on this far, it’s time for us to drop the most remarkable, and perhaps most unconventional, tax tip for self-employed independent contractors: Hire your kids. Need assistance with transcribing meetings? Little Susie might be willing to do it for $5 an hour. Planning to spruce up the office? Timmy could lend a hand at a low cost. Heck, you might even persuade Sally to tackle your tax filings for you!

It’s not just that your children are easily persuaded and readily available. The real kicker is that you can deduct their wages on your Schedule C (business profit and loss) form. If they’re under 18, they’re exempt from Social Security tax, and if they’re under 21, they’re also exempt from Federal Unemployment Tax. Furthermore, they probably won’t owe taxes at all if their earnings are modest—and the money you’re paying them doesn’t count toward your taxable income. Just keep in mind that you must pay them reasonable wages. But don’t worry, there’s no need to be stingy—you can even contribute to IRAs for them.