How to claim business tax deductions as a freelancer
Running a business isn’t cheap. You may need special equipment, a steady stream of supplies, or access to a workspace outside of your home. All of these costs can quickly add up and eat into your income.
Thankfully, as a business owner, you can deduct the expenses that you had to pay to run your business. You can use these deductions to show how much money actually went into your personal bank account. Rather than paying taxes on all of the money you received from your clients, you will base your tax calculations on this adjusted amount of income, decreasing the amount you owe in taxes.
What are tax deductions?
Tax deductions are a way for small business owners to avoid paying taxes on money they spent to run their business. You can’t just claim any expense, however. The IRS only allows you to deduct necessary and ordinary expenses. It defines these deductions as:
- Necessary - “A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
- Ordinary - “An ordinary expense is one that is common and accepted in your industry.”
You will have to defend all of the deductions you’ve taken if you’re ever audited. If the IRS can prove that you shouldn’t have taken any deductions, you will have to pay the taxes you avoided, interest on that amount, and penalties.
Common business deductions for freelancers
When you take business deductions, you won’t make a list of each individual cost. Instead, you will group these expenses within one of the categories given in part II of your Schedule C form.
Though your costs are unique to your work and how you run your business, here are some of the most common business tax deductions that freelancers are typically eligible to take.
Most freelancers work from home, giving them the chance to use the home office deduction. If you want to qualify for it, though, you will need to have a space in your home that is only used for business purposes and utilized on a regular basis. This space should be your primary place to complete administrative tasks, meet with clients, store inventory, and/or do your work.
If you have another off-site business space, such as a coworking office space that you rent, you cannot claim the home office deduction. If you have a desk set up in your bedroom or living room, you are also exempt from this deduction.
This is one of the most complex and scrutinized deductions, so use it carefully.
If you have to drive to business meetings, to pick up supplies, or to visit worksites (such as working on vehicles at your client’s home), you can get a deduction for this travel. To claim these savings, you have two options:
- Mileage - You can multiply the standard mileage rate by the number of miles you drive for work.
- Expenses - You can deduct the expenses of using your vehicle (such as gas, insurance, oil changes, tires, and depreciation), but only the percentage used for business purposes. If 20% of your car use is for business, for example, you can deduct 20% of your expenses.
If you drive a lot, the standard mileage rate may offer a bigger and easier return. If your vehicle consumes a lot of fuel or you have high insurance costs, however, it may be better to deduct your expenses.
You can only choose one of these deductions for any given tax year. If you choose to deduct expenses, you must keep track of all of your costs and mileage throughout the year. You won’t be able to switch the deduction you want to mileage later on.
If you use business cards, flyers, social media or Google ads, a website, Yellow Pages, or any other tool to promote your business, you can deduct these costs under the advertising category. Paying for a logo design or rebrand also qualifies for this section.
Items such as postage, paper, and pens, anything that you can buy at an office supply store, can be deducted under the office expenses section.
Other items, such as professional equipment, books, office furniture, and any other supplies required to run your business, can also be deducted from your total income. If you buy a new computer and don’t want to depreciate the cost over time, for example, you can usually deduct the expense under the supplies category, depending on the IRS rules for accelerated depreciation during the year.
Taxes and licenses
In many states, you have to pay an annual fee to keep your business registration active. This cost, as well as other licenses and regulatory fees paid to the local/state government, can be deducted. You can also deduct:
- State/local personal property taxes
- Real estate taxes for land used only for your business. If you qualify for the home office deduction, you can also deduct a percentage of your home real estate taxes. If your office is 10% of your home, for instance, you can deduct 10% of your real estate taxes.
- Sales and excise taxes on business purchases
If you pay for business insurance, you can deduct the costs of your premiums from your business taxes. While you can also deduct health insurance costs paid for yourself and your family, that is a personal deduction that you will record on your Form 1040, not as a business expense on your Schedule C.
Deductions you might not think about
There are many ways that freelancers invest in themselves and their businesses to grow and improve. As long as you can show that your investments directly applied to your business, you can avoid paying taxes on them. Some of the costs you can deduct include:
- Education - If you paid for a course to learn a new skill or stay up on industry changes, you can deduct this cost in the “other expenses” category. If you hired a business coach, you can deduct that cost from the “legal and professional services” category.
- Travel - If you have to travel for business purposes for longer than a day, you can deduct travel costs, 50% of the cost of meals, overnight lodging, tolls, parking fees, and costs to ship business materials to your destination.
- Tax help - Did you hire a tax professional to help with your taxes last year? You can deduct this cost from your income under the “legal and professional services” section.
- Freelance tools and platforms - Freelancers rely on numerous resources to complete their work and maintain their businesses. You can deduct subscription and sales costs for the different software, platforms, and tools you need, including Hectic! These deductions can be included under the “other expenses” category on your tax return.
Common business deduction mistakes
One of the most common mistakes small business owners make when claiming deductions is taking both mileage and actual automobile expenses deductions. Remember, you can only claim one of these options.
Many freelancers also run into problems because they don’t have separate bank accounts and/or credit cards for their business expenses. Combing through your statements to find business costs is tedious and difficult, making it easy to miss deductions you deserve. Instead, keep all of your business transactions separated from your personal finances. Store receipts and records for all of your expenses throughout the year in a folder or box to make filing your taxes easier.
You can also use a tool like Hectic to keep track of your income and expenses. Our at-a-glance profit & loss reporting feature shows you where you stand at all times, helping you prepare for tax season in advance.
Do client expenses count as deductions if I get reimbursed for them?
Nope, sorry. You will either need to include the reimbursement in your income if you add it as a deduction or leave both out of your records.
How to file business tax deductions
When you file your taxes, you will calculate the total expenses for each of the categories in part II of your Schedule C form. Make sure to look through each of these categories to see if you are eligible for that deduction, even if you don’t think it applies to you.
Being smart about tax deductions
When you claim a deduction, you are saving the amount of taxes that you would have paid on the money the expense cost, not saving the full amount of the expense. If you bought a new computer for $600, for example, you would likely save about $100 with the deduction, not the full $600.
With this in mind, don’t make unnecessary purchases for the deduction alone. You will end up paying more than you save, by a significant amount.
The one exception to this advice is if the deduction drops your income out of your top tax bracket. Let’s say you made $45,500 during the year and you could buy a $5,000 piece of equipment that is nicer than you need, but will still benefit your business. That expense lowers your income to $40,500, which takes you out of the third tax bracket. Now, you don’t have to pay 22% of that $5,000 and can enjoy your new equipment instead.
If you do use this option, you will need to make your purchase before December 31st so that it qualifies for that tax year. We also caution against going into debt for a deduction. Make sure you understand how much your purchase will cost (including interest on credit card debt, for instance) before making it.