More and more Americans are finding careers as freelancers these days. While you can easily find joy in being your own boss, figuring out what you can and can’t take as tax deduction might not be one of them. A tax deduction is an item which decreases your taxable income, which in turn decreases the amount of taxes you have to pay to the government. And as a freelancer, you have more tax deductions available to you than if you were a full-time employee. But getting the most out of your tax deductions and expenses can get complicated really fast!
By now, you have probably received your 2016 credit card and bank statements. Now you wonder as you go through them, “What can I deduct from your income?”
So let’s shed some light on the basic tax deductions you can take. The general IRS guideline for any tax deductions is that expenses must be ordinary and necessary in the active conduct of your business.
Most freelancers work from home, so this is one deduction you may qualify for. If you use a part of your home “exclusively and regularly” as your primary business space, you may be able to deduct certain expenses. But say you work at the kitchen table with your laptop for 8 hours, IRS will not allow you to deduct that space because it doesn’t meet the strict exclusive-use test.
To calculate the deduction, you can choose between the simplified or the regular method.
Simplified Method: This option as the word implies is very easy to calculate. You simply multiply the allowable square footage of your office by a rate of $5. The maximum footage allowed is 300 square feet (for a maximum deduction of $1,500).
Regular Method: Under this method, you must first determine the percentage of your home used as your primary business space. You either calculate this by square-footage or by the number of rooms (if the rooms are similar in size). That percentage is then multiplied by the qualified household expenses such as your mortgage interest or rent payment, utilities, insurance, etc.
Equipment, Office Supplies
This includes things like office essentials, postage, books, professional instruments, equipment like computer, laptop or printer. Any other items or materials you need for your business can qualify for a deduction.
For bigger ticket items such as computer, laptop or printer, you can either take the full deduction in the year you purchased it or spread the cost over its lifetime (or what we call “depreciate the asset”). The IRS has guidelines on depreciating such equipment over its useful life. If you are not sure which option to take, a good rule of thumb is that if you think that you will have higher income in the next years, you can choose to spread the cost of the item and not deduct the full cost of the equipment on the year of purchase. That way, it will be more beneficial in those years when you have high income.
Travel, Meals and Entertainment
When you travel away from home for business, the costs you paid for such as plane tickets, hotels, taxis, tips to bellhops and porters are allowed as deductions. However, if you brought your family with you so that they can sight see while you work, you cannot deduct their travel expenses.
Also in general, you can deduct 50% of your business-related meal and entertainment expenses. Keep in mind that business meal expenses are only deductible if (1) they are deemed ordinary and necessary in the conduct of your business – which is the IRS general rule; (2) the expenses have to be reasonable and not lavish or extravagant; (3) and incurred while you or your employee is present at the meal.
What is considered lavish or extravagant by the IRS is quite vague other than its determination is made based on the facts and circumstances. It’s good to keep in mind though that when you have serious doubt about the “reasonableness” of the business transaction, don’t expense it (or at least a portion of it).
Car and Truck expenses
You can deduct the actual expenses of operating your car or truck or take the standard mileage rate. Actual expenses include gasoline, oil, repairs, insurance, license plates, parking fees, etc.,
If you choose to take the standard mileage rate, you have to first determine the number of business miles driven during the year and multiple that number by 57.5 cents. Add to this amount your parking fees and tolls as well.
Other items that may be deductible include:
- Advertising – Expenses for business cards or any materials used to promote and advertise your business.
- Contractors and Professional fees – This includes contractor you hired directly related to the conduct of your business such as designers, programmers. It also includes your accountant, bookkeeper or lawyer.
- Insurance – Any premiums you paid for various types of business insurance such as general and professional liability insurance, malpractice insurance, workers’ compensation insurance, etc. Renter’s or homeowner’s insurance can be claimed as a part of your home office deduction for a qualified home office.
- Utilities – Telephone, cellphone and internet directly used in running your business can be deducted. You can also include your domain and web hosting expense, or any apps and online tools subscription you used in your business.
- Interests and bank fees – This includes interests on loans you took during the year for your business, credit card interests (for your separate business expense account), and mortgage interest only on the percentage allowed under your home office deduction.
- Education and Professional Development – Includes the cost of education or training to further your business skills.
- Rent or lease of vehicles, machinery, equipment and other business property.
- Equipment repair.
Bonus deduction: Cost of coffee while working at a coffice (aka coffee shop).
If you have not incorporated, the items above will go on a Schedule C form that is attached to your 1040 form. Freelancers with expenses less than $5,000 with no employees, and did not sustain a net loss and did not deduct expenses for business use of your home can use the simplified Schedule C-EZ.
While we have provided some basic guidelines regarding tax deductions, it’s still highly recommended to reach out to a professional who can give a more thorough look at your finances and can provide the proper tax solutions to your needs. Be sure to get the most of your tax deductions!