In today’s ever-evolving job market, more and more individuals are embracing the freedom and flexibility of freelancing and taking advantage of self-employment tax write-offs (write-offs are just another word for deductions). While these career choices offer countless advantages, they also come with unique financial responsibilities, especially when it comes to taxation. Navigating the world of self-employment tax write-offs as a freelancer or self-employed person can be daunting and rewarding.
Whether you’re a seasoned freelancer or considering making the leap into self-employment, I made this guide to shed light on the intricacies of your tax return, your tax write-offs, and your tax bill in your professional journey, helping you make the most of self-employment tax write-offs.
Effective tax planning is a fundamental principle of financial success for freelancers and self-employed taxpayers. By strategically managing your tax write-offs, you can minimize your tax bill and leave more money in your pocket. This means greater financial stability to be able to invest in yourself and your business.
The plan of action you can take tailored to your unique circumstances as a freelancer or self-employed person:
- Maintain Organized Financial Records
- Understand Self-Employment Tax Write-Offs
- Claim All Deductible Business Expenses (tax write-offs)
- Explore Tax Credits for Self-Employed taxpayers
- Retirement Plans for Tax Reduction
- The Home Office Deduction for Home Office Space: What You Need to Know
- Quarterly Estimated Taxes: Staying Ahead
- Choosing the Right Business Structure
- Seek Professional Guidance
The importance of maintaining organized financial records throughout the year.
Every receipt, invoice, and expense record may seem insignificant on its own, but altogether, these small details can help you with significant tax savings. Keeping track of these things is very significant in tapping into opportunities that many may overlook. This meticulous record-keeping not only simplifies tax preparation but also empowers you to make informed financial decisions year-round.
When you maintain detailed records of your financial transactions, you gain a comprehensive view of your self-employment gross income (gross revenue), expenses, and net earnings (net profit). This empowers you to identify every possible tax advantage available to you.
For instance, a freelance graphic designer keeps thorough records of their business expenses. In their records, they have receipts of software subscriptions, equipment purchases, and home office space expenses. With this information at hand, they can claim deductions for these expenses, reducing their taxable self-employment income. Furthermore, they discover that they qualify for the Earned Income Tax Credit (EITC) based on their income and family size. Their well-organized financial records helped them to confirm that they meet the EITC’s criteria. Without these records, they might have missed out on these opportunities and overpaid their taxes.
For freelancers and self-employed people looking to streamline their financial management, a variety of digital solutions are available. Accounting software like QuickBooks, Xero, and FreshBooks offer user-friendly interfaces and features tailored to self-employment needs. Yari Solutions offers heavy discounts on Quickbooks and Xero, including 50% off Quickbooks for the first three months to one year, upon sign up. These resources allow you to categorize self-employment income and expenses, generate reports, and even integrate with your bank accounts for automated tracking. These accounting apps or accounting software packages include mobile apps to help you digitize and organize receipts and documents on the go. Here at Yari Solutions, we’re experts in customizing the program or app of your choice as well as “tech stacking” (making your apps work together). However, keep in mind that the choice of tool or software ultimately depends on your preferences and specific needs, but investing in the right tools can make the process of maintaining organized records far more efficient and less time-consuming.
Understand Self-Employment Tax Write-Offs
Self-employment taxes differ from W-2 employee payroll taxes (taken from your paychecks).
Firstly, self-employed taxpayers, including freelancers, independent contractors, and small business owners, are responsible for paying both the employee and employer portions of these taxes. While W-2 employees split these tax responsibilities with their employers, self-employed taxpayers carry the full burden.
Secondly, the self-employment tax rate is typically higher than the combined W-2 employee and employer tax rates for Social Security taxes and Medicare taxes. As of 2023, the self-employment tax rate is 15.3%, with 12.4% going to Social Security taxes and 2.9% to Medicare taxes. In contrast, traditional employees pay half of these rates, with their employers covering the other half through payroll taxes.
However, don’t let this worry you or deter you from self-employment if you’re just considering it. Being self-employed far outweighs being an employee in terms of freedom and long-term benefits.
Claim All Deductible Business Expenses
The good news here is that freelancers have the advantage of deducting a variety of common business expenses to reduce their taxable income, thus lowering their overall tax bill. Employees do not have this advantage. These standard deductions not only include costs related to maintaining a home office space (expenses associated with business use of a dedicated home office, such as rent or mortgage interest, utilities, and insurance), but also acquiring equipment necessary for their work and investments in marketing efforts. When it comes to equipment, computers, software, and office furniture can be deducted as business expenses. Travel and transportation costs, whether for client meetings or attending industry events, are also deductible. This includes mileage, airfare, hotels, and meals. Marketing expenses include like website hosting, social media advertising, and promotional materials. In my opinion, this is one of the best aspects of being a freelancer, contractor, or self-employed person. I must stress the importance of maintaining detailed receipts and documentation of your financials in order to make the most of these deductions.
The ability to claim business deductions can vary widely depending on the business they’re in.
Example 1: A client who was an interior designer working from home used his home as a showroom instead of opening a showroom location. He would bring clients to his home to show them his work. He also stored design items in his garage. This allowed him to write off his home as a business showroom.
Example 2: A client who was a marketing consultant had to live out of state for most of the year to service his large clientele. Staying in hotels became too expensive, eating into his profits. He spent a few years building the business in those locations, therefore, he purchased a condo, which at the time was much less expensive than staying at hotels. He wrote off the condo expenses as a business expense.
Example 3: I was a sole proprietor for many years and I’ve worked from home for 15 out of 18 years. Sole proprietorship worked perfectly for me. I wrote off my home office space, my car, my internet, my utilities, and some food as office supplies (snacks, coffee, fruit, etc.) all things you would pay for in an office.
Taxes are like investments- your strategy depends on your risk tolerance. Like one of my clients once said, “You can get as creative as you want with your expenses, just don’t hide your income.” He’s right. This is where people get in trouble the most. It’s not with the expenses they write off, it’s with the revenue they hide. Don’t ever do that.
Here at Yari Solutions, we’ll find the strategy that works for you and your business.
Explore Tax Credits for Self-Employed Taxpayers
Tax credits, such as the Earned Income Tax Credit (EITC) and the Child and Dependent Care Credit, offer other opportunities for freelancers and self-employed workers to reduce their tax bill. The EITC, for instance, is designed to benefit low-to-moderate-income individuals and families. It’s a refundable credit, meaning that if the credit exceeds your tax liability, you can receive the excess as a refund. To claim these credits, you must meet specific eligibility criteria. This includes income thresholds and, in the case of the Child and Dependent Care Credit, expenses related to child or dependent care.
Retirement Plans for Tax Reduction
Self-employed taxpayers have several retirement plan options, such as the Solo 401(k) and SEP-IRA, tailored to their specific needs. These plans not only help secure their financial future but also offer significant tax advantages. Retirement contributes to tax savings by deducting your contributions from your taxable self-employment income in the year you contribute. Also, your investments grow tax-deferred, meaning you don’t pay taxes on the gains each year, allowing your investments to potentially grow more quickly. You only pay taxes when you withdraw the money during retirement, ideally at a lower tax rate.
The Home Office Space Deduction: What You Need to Know
Claiming a home office space deduction as a self-employed individual necessitates meeting specific requirements. Your home office space must be a dedicated space used exclusively for business use (any size applies including say a bathroom and a lounge area dedicated only to client visits), and it should be your principal place of business. To calculate and apply this deduction, measure the square feet of your home office space in proportion to your entire home, which will determine the percentage of certain home-related expenses you can deduct, such as rent, utilities, and insurance. However, it’s crucial to be accurate in your calculations and to maintain meticulous records, as misconceptions and discrepancies related to the home office deduction can trigger audits and raise red flags with the IRS.
Quarterly Estimated Taxes: Staying Ahead
Quarterly estimated tax payments are a critical aspect of self-employment taxation, designed to help freelancers and self-employed workers prepay their income and self-employment taxes throughout the year. To ensure accuracy, you can use the provided guidelines and forms for estimating and submitting these payments. It’s essential to base your estimated payments on realistic income projections and to stay on schedule with timely submissions, as underestimating quarterly payments can result in penalties and interest charges. You only need to worry about this if your business is very profitable with a high-profit margin (meaning that you’re keeping most of your income even after paying all business expenses- a lot of service businesses deal with this because the product of the company is time). If you’re having a hard time coming up with an amount to send to the IRS every quarter and you want to at least send something to not be hit with a large tax bill, start with what you expect revenue to be in the current tax year. If it’s close to that of last year’s, take a look at your previous year’s tax return and see what tax bracket you fell into (did you pay 20% in taxes? 15%? 30%?) and use that as a guideline to make estimated tax payments each quarter.
Example: Your revenue was $150,000 last year. You paid 20% in taxes (you should see the % in your tax return). If you expect to earn around the same in revenue this year, and say last quarter your revenue was $30,000 after business expenses, it would be safe and wise to send $6,000 of estimated taxes to the IRS for the quarter. However, the tax write-offs and tax credits will be deducted, so you can technically send slightly less. This is why up-to-date accounting and bookkeeping are so important to maintain.
A lot of people think overpaying is a good idea, however, you’re negatively affecting your cash flow by locking in monies you could be using to run the business. If you underpay your estimated taxes, you have three months after year-end to close and review the previous year’s financials and make a tax payment to balance it all out. It will take some practice over two or three years for you to find a good balance between paying too much and not paying enough.
Choosing the Right Business Structure
Choosing the right business structure is a pivotal decision for freelancers and self-employed individuals. It will directly impact your tax obligations and legal responsibilities. By comparing structures like sole proprietorship, LLC, and S-Corporation, you can gain insights into the tax implications associated with each.
To select the most tax-efficient business structure for your freelance business, it’s essential to consider factors such as your expected self-employment income, business complexity, and liability protection needs. Sole proprietorships are simple but offer no liability protection, while LLCs provide a middle ground between simplicity and liability protection. S-Corporations can offer potential tax savings through pass-through taxation, making them a good choice for more established businesses with higher profits, but they involve more administrative requirements. It is also important to revisit this choice as your business evolves and grows to ensure that your tax strategy remains aligned with your business goals over time.
In my experience controlling finances for clients all these years, I always see “solopreneurs” jumping into LLCs and S-Corps too early, costing them too much time and money setting up and maintaining those structures. The truth is that sole proprietorship works for solopreneurs for the majority of the time. A lot of businesses don’t bring in enough revenue in the first and even second year to excuse the expenses of an LLC or S-Corp.
Seek Professional Guidance
The value of consulting a tax professional, accountant, or financial controller cannot be overstated for freelancers and self-employed individuals. These experts possess in-depth knowledge of tax regulations and can uncover additional tax-saving opportunities that might otherwise go unnoticed. They also play a crucial role in ensuring full compliance with tax laws to reduce the risk of audits or penalties. To make the most of this partnership, carefully choose a qualified professional, establish clear communication, and provide them with accurate financial records, allowing them to tailor their advice to your unique situation and help you maximize your tax savings.
Aligning your business decisions with some of these tax-saving strategies can contribute to long-term financial success as a freelancer or self-employed person. Meticulous record-keeping, understanding self-employment tax write-offs, maximizing deductible business expenses, and leveraging tax credits are some tax-saving and overall tax strategies you can use to help yourself and your business thrive. I encourage you to take proactive steps and put these strategies into action. By integrating these practices into your financial routine, you can secure significant tax savings and achieve greater financial stability. Contact us at Yari Solutions where we have spent close to two decades mastering all of these strategies and will apply them to your business along with unique and personalized guidance tailored to your specific circumstance.