One of the first questions we often get from freelancers, especially new ones who are just entering the world of self-employment, is which expenses can be deducted.
Freelancers are required to list all of their income and expenses related to their business on what is known as Schedule C of their tax return. The net profits earned from self-employment, which is the income less expenses, are then taxed along with any other income using the personal income tax brackets.
So it’s no surprise that freelancers are interested in understanding what they can deduct, because all those expenses offset income on their tax return and result in true savings come filing time. This article will get you started with an overview of how to evaluate which expenses can be deducted based on your self-employed profession.
Guidelines to Eligible Deductions
Freelancers can deduct expenses that are directly related to their trade or business. A plumber can deduct the cost of tools, for example. Likewise, a graphic designer can deduct the cost of image editing software. And an Uber driver can deduct the cost of fuel and automobile insurance.
Generally speaking, to be tax-deductible, an expense must be related to your trade or profession. The expense should be common in your industry, and helpful and appropriate for the kind of work you do.
There are ten things freelancers need to know about deducting expenses related to their trade or business.
- Expenses are recorded on your tax return in the year in which you actually pay them.
- You will need to keep track of your expenses and provide a summary to your accountant at tax time.
- If audited, the IRS will ask you to substantiate your deductions. This means you will need to provide proof of payment (such as receipts and invoices) and will need to explain how the expense is related to your trade or business.
- If you pay another freelancer more than $600 during the year to do some work for you, you may need to issue a Form 1099-MISC.
- If you regularly and exclusively use part of your home to conduct business, you can deduct rent, insurance, repairs and other expenses related to your home office.
- You can also deduct the business use of your car or truck. There are two methods to do so: using actual expenses or applying the IRS’s standard rate to miles driven.
- Travel expenses can also be deducted. You should keep records to prove the travel was directly related to your business.
- Meals and entertainment expenses are partially deductible: we can write off only half the total cost. You should keep records to prove the meal or entertainment was directly related to your business.
- Insurance expenses related to your business are typically tax-deductible. Even personal insurance, such as medical and car, can be tax-deductible in some cases. Keep track of insurance expenses by the type of insurance it is.
- The cost of equipment, computers, software, furniture, and other assets might be deductible in full in the year purchased, or the cost could be spread out over a number of years (known as depreciation). The IRS has rules that determine the timing of the deduction.
When to Deduct Expenses
Generally speaking, freelancers deduct their expenses in the year the expense was paid. That’s because most freelancers use the cash method of accounting. Under the cash method, we include as income all items of income that a person actually or constructively received during the year. And similarly, we deduct expenses in the year in which the person paid the expense.
Keeping Track of Your Expenses for Tax Time
Freelancers will need to keep track of the income and expenses related to their freelance trade or business. Then, a tally of all income and expenses for the year should be given to your accountant and used to prepare your tax return.
Freelancers can track their income and expenses in any number of ways. This can be done using paper, an electronic spreadsheet, an app, or financial software.
The important thing is that expenses should be added up by category. Expenses should be grouped into categories such as these:
- Advertising, marketing and promotions,
- Car and truck expenses,
- Commissions and fees,
- Contract Labor,
- Depreciation related to equipment, computers, software, furniture, and other fixed assets
- Employee benefit programs
- Estimated tax payments to IRS
- Estimated tax payments to state
- Insurance (other than health)
- Health insurance
- Interest expense
- Legal and professional services
- Office expense
- Pension and profit-sharing plans
- Equipment rentals
- Office rent
- Repairs and maintenance
- Business taxes and licenses
- Meals and entertainment
- Wages paid to employees
- Other expenses directly related to the trade or business
- Expenses for business use of home
How to Prepare for an Audit
Sometimes, the IRS wants to verify items reported on your tax return. This is called examining or auditing a tax return. If audited, the IRS will ask you to provide proof of payment (such as receipts and bank statements) and explain how the expense is related to your trade or business.
Freelancers should keep financial and tax documents related to entries made on the tax return. This includes documents such as:
- Receipts and invoices
- Bank statements
- Credit card statements
- Log of miles driven for business
- Any spreadsheets or software used to tally up income and expenses
- Tax documents such as Forms 1099
We recommend that freelancers maintain these financial records in a safe location for at least seven years. That’s because the IRS can audit a tax return up to three years after the return is filed. And some states can audit a return up to four or five years after the return has been filed.
Tax Move Takeaways
- Freelancers can deduct expenses that are related to their business.
- Keep receipts, bank statements, and credit card statements to prove you paid for the expense.
- Maintain an ongoing tally of your expenses by category. Give this tally to your accountant at tax time.
- If you’re not sure if something is deductible, ask your tax advisor.
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