Taxes, taxes, taxes, aren’t they just so fun? There are two nightmare scenarios when it comes to paying your taxes for your freelance business:
- You overpay your taxes, leaving you with less in the bank!
- You underpay your taxes, putting you at legal risk and potentially sets you up to pay penalties and interest later on.
In this tutorial, I’m going to share three tips that you can use to file your taxes properly and lower your expenses legally.
(Full disclosure: this freelancer has two accounting degrees, but I am not a CPA and don’t work as a Tax Accountant. The advice in this article is not proper tax counsel, and should be reviewed under advisement with a CPA or EA)
You probably already know that saving money on your taxes is all about deductions. A deduction is an expense that you can legally subtract from your earnings for the year. Generally, you’re taxed on income minus expenses, or basically your business profits.
If you’re going to claim an item as a deduction, it has to be related to your business. You can’t simply expense the couch that you bought that you sometimes sit on while writing an article. Even a computer that you use for your work can only be deducted for the percent that qualifies as business use.
To deduct an expense from your income, it’s important to have proper documentation. If the IRS wants to review your return in detail, (in the form of what’s called an audit) you might need to present paperwork and documentation for any expenses that you claimed as a deduction.
In addition, there are two key deductions that you might want to consider if applicable:
- Business mileage – use your car to travel to meetings and business events? You can deduct expenses for using your car per mile. In 2018, every business-related mile allowed you to deduct 54.5 cents from your income (for example, 1,000 miles means $545 of deductions from your income
- Home office allowances – if you have a dedicated space in your home that you use solely for business, you can deduct expenses related to that area. There are a couple of methods for calculating this expense, including the easy Simplified Option that’s pretty new.
Turn to a Professional
Above all, the most important part of protecting yourself when preparing for tax time is to let a professional help you prepare your return.
The advice that I’ve shared in this article is a good starting point, but a tax professional will talk to you about your personal situation. They’ll be able to identify deductions that might apply to your specific situation. Your freelance business is just one part of your life, and your entire life (marriage status, children, state taxes) influences your overall tax situation.
In addition, most CPA’s work with a variety of types of clients, including freelancers. That means that they’ll be familiar with the types of questions to ask and have ideas on deductions. For me, going through that conversation with an accountant will remind me of items I might have forgotten to deduct.
Hiring an accountant can also help you prepare for the next year. The prior year is already closed and in the books, so there’s not much you can do about it.
Accountants charge for their services. But, you’ll recoup that investment in multiple ways:
- Catching deductions that you might not think about on your own
- Planning for future years, putting a tax plan in place that reduces your liability
- Ensuring your taxes are filed properly, which pays dividends in the form of peace of mind and avoiding penalties later on
Contribute to Retirement Accounts
Generally speaking, the U.S. tax code is written to encourage certain behaviors from taxpayers. The complexity of the code often comes from all of the deductions and credits that are built in to drive certain actions from taxpayers.
A great example of that is the deduction allowed for retirement contributions. If you’ve worked a day job before, you might be familiar with retirement accounts like 401(k) accounts. But, as a freelancer, you also have options for starting your own investment accounts.
Again, this is another area that you’ll want to consult a professional on, including your CPA. There are multiple types of investment accounts (SEP-IRA’s, Solo 401k, Traditional and Roth IRA accounts) that will vary from one person to the next.
Not only does contributing to your retirement fund help you prepare for your future, it also can reduce your tax liability. Depending on the type of account you choose, you may be able to deduct your contributions or withdraw your investments later on with the growth tax-free.
Above all: make sure that you consider at least one of these accounts and discuss it with a professional.
When it comes to taxes, it’s important to pay what you owe. But it’s also important to pay only what you legally owe. Following these tips helps you hit that sweet spot and removes the stress of the tax filing process.