Freelancing can be stressful during the best of times—but it's never more so the case than at tax season.
By some counts, there are as many as 42 million independent workers in the U.S. today. But come spring, whether you’re freelancing as a management consultant, web developer, journalist or something else entirely, you may be asking yourself one crucial question: What can I deduct on my taxes this year?
That's why we asked Jonathan Medows, a New York City–based certified public accountant who specializes in taxes for freelancers, to help us explain how deductions work for this group of workers, what to keep in mind when figuring out what to deduct as a freelancer, and which expenses typically qualify toward those deductions.
Deductions 101: How Do They Work?
Once you've accounted for all of last year's income (whether it came with a 1099 or not), the next step is to start chipping away at that income through—you guessed it—deductions.
A tax deduction is an expense that you can subtract (aka "deduct") from your overall taxable income, exempting that cash from taxation and subsequently decreasing the overall amount of money that's subject to tax. "The whole point of deductions is to reduce your tax liability,” Medows explains. “So if you have $100,000 of freelance income, and $20,000 of expenses that you can deduct, your tax will only be based on $80,000 of profit.”
That said, tax preparation for freelancers "gets very complicated very quickly,” Medows cautions. So while we're able to give you some general guidelines and things to keep in mind when thinking about deductions, only a professional familiar with your finances will be able to give you proper tax advice tailored to your specific situation.
A professional can also keep you updated on changes to the tax code—like the fact that the self-employment tax rate went from 13.3% to 15.3% in 2013, thanks to the expiration of the tax holiday during the recession. (And, in fact, half of that tax is deductible.)
And while you don't have to work with a pro, Medows warns that the self-employed (that's IRS-speak for "freelancers") tend to be at higher risk of audits, so it's critical to keep detailed documentation of your expenses. “You don’t want to cheat yourself,” he explains, “but you also don’t want to cheat the government. You want to be able to look someone in the eye and explain and justify your deductions.”
In fact, Medows encourages freelancer clients to hold on to receipts and documentation for six years—double the time officially recommended by the IRS. “If you are audited, the government will insist on seeing receipts,” he says. “People think that having a credit card statement is enough, but it's not. If you buy something from Amazon, the government wants to know that it’s surge protectors for your office—not toys for your kids.”
If you find yourself pressed for storage space, Medows recommends scanning old receipts, as well as backing up the digital files. Because if you do end up being audited and can’t back up your claim, you could lose the deduction and be on the hook for the tax—plus interest and a penalty.
When deciding what to deduct, Medows suggests asking yourself the following question: “Would I have this item anyway if I didn’t use it for business?” If the answer is yes, tread carefully. “Is it worth the risk to save $100 on taxes?”
What Exactly Can a Freelancer Deduct?
As a rule of thumb, a freelance or self-employed worker can typically deduct things that fall under three categories: what you use, what you eat and where you work. Or, as Medows puts it, “gear, food and places to put your butt.” There are important exceptions, however, so make sure to read the IRS rules carefully to see how they apply to you.
“You are allowed to deduct any expenses that are ordinary and necessary in order to generate your freelance income,” says Medows, who suggests freelancers start by revisiting last year’s credit card and bank statements to review exactly how they have been spending. These items will go on a Schedule C form (if you haven’t incorporated), which freelancers are required to file with their annual tax return to report all gross income and business expenses. (Freelancers with expenses less than $5,000 who have no employees and aren’t deducting the cost of a home can use the simplified Schedule C-EZ.)
So which expenses are usually considered "ordinary and necessary?" Start with these:
Home Office If you have a dedicated space in your home where you work, it may be eligible for a home office deduction. But be careful: The IRS doesn’t allow you to deduct the space if your “office” becomes the kids’ playroom after 5 p.m., or if you work at the kitchen table with a laptop.
If you do have a spare room that's used exclusively as an office, you have two ways of writing it off. The simplified version (offered for the first time in 2013) allows you to write off $5 per square foot of space on up to 300 square feet, for a total maximum deduction of $1,500.
The "regular" version requires more elaborate calculations, including your mortgage payment and the percentage of your house that's used for the office. If you're used to employing that method for your calculations (or if you live in a particularly high-rent city, and want to claim more than $1,500), you may choose to go this route. For more information, the IRS has published a side-by-side comparison of how the two methods work.
Office Supplies and Equipment The IRS allows you to deduct basic office supplies used in the course of your work, such as paper, pens, files and calculators. Other deductible items include computers, software, web servers, printers and equipment related to your everyday work. If you are a freelance photographer, for instance, you might be able to deduct film costs and processing fees. And a freelance editor could potentially deduct reference books and magazine subscriptions.
Larger items, like the above mentioned computer or software, are considered business assets. So you’ll need to decide if you want to deduct the full cost in the year you purchased them, or spread the cost out over the lifetime of the asset, which is called depreciation. While a tax professional can help you decide whether or not to depreciate, you may want to spread the cost of your purchase out if you think that you'll have a higher income in the future, or deduct it all today if you don't anticipate an uptick in your income.
Remember, though, that when items like telephones or internet service are used partly for work and partly for personal reasons, "you’re in a gray area," Medows says. If you're unsure of how to deduct your office supplies and equipment, the IRS has extensive guidelines.
Travel and Meals Travel costs for business—plane tickets, cab fares and hotel stays—are deductible, although the cost of commuting to an office isn't. You can also typically deduct 50% of your business-related meal and entertainment expenses, such as taking a prospective client out for coffee or eating dinner alone on a business trip. And keep in mind that a weekend at a reasonably priced hotel for a two-day industry conference will be less likely to raise a red flag during an audit than a weeklong stay at an expensive resort.
Professional Development If you take classes for professional development—like a writing seminar if you are a freelance writer, or a coding course if you are an independent web developer—the cost of these classes is typically deductible. Ditto any dues for memberships in professional organizations related to your work.
Miscellaneous Other items that may be deductible include:
- Payments to other freelancers who perform work for you
- Bank fees for your business
- Health insurance premiums (in fact, you can be charged a penalty if you don't have health insurance)
- Equipment repair
- Telephone and internet bills for service directly related to your work
You cannot, however, deduct business clothing unless it's a uniform or safety equipment, cautions Medows, who often sees this mistake. Tip: The Freelancers Union offers a good step-by-step guide to figuring out deductions for miscellaneous items.
And, on the bright side, you can deduct the cost of tax-preparation services!
Want to learn more about doing your taxes as a freelancer? Visit the Self-Employed Individuals Tax Center at IRS.gov.