Freelance finances: The tax challenge

Chris Morris

By Chris Morris
Chris Morris regularly writes for national outlets including CNBC.com, Fortune and Variety.
Posted on Oct 20, 2022

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Note that freelancing is growing area attracting lots of interest since the pandemic.

Point out that tax rules and regulations are significantly different than for salaried positions.

List common and uncommon deductions freelancers can consider.
 
     

The freelance world has looked a lot more appealing to many people in the days since the pandemic upended everything. What once was tempting, but had entirely too many potential hurdles for most people, has become something that’s a serious consideration.

It’s not just temporary freelancing between gigs, either. The 2021 Freelance Forward Report from Upwork, a company that connects businesses with freelancers, found that 2 million people started freelancing on a full-time basis in 2021. And the Bureau of Labor Statistics found that self-employment jumped 7 percent compared to the pre-pandemic days.

It’s an exciting move to make, but one that also requires a lot of self-awareness and discipline — and not just on the work you manage to bring in. In the absence of a corporate human resources department, you’ll be responsible for putting together your own benefits package. (Related: The freelancer’s benefit checklist)

And your tax situation becomes a lot more complicated.

Freelancer quarterly taxes

“Most freelancers are unaware that they have to pay quarterly taxes,” said Moira Corcoran, a CPA and finance expert. “Compared to salary workers, taxes for freelancers are much more complex. Since they do not have withholding on their earnings, they have to calculate and remit their taxes [every three months].”

Four times a year, you’ll have to write a check for your estimated taxes (which mimics the tax withholding from salaried workers’ paychecks). That can be challenging, since there’s not a lot of income stability for freelancers. You never know in January if you’re about to have a boom or bust year. Overestimate what you owe and you could face a cashflow problem. Underestimate and you’ll face a potentially huge bill the next time April 15 rolls around.

On top of all of that, since you don’t pay into Social Security or Medicare, you’ll be responsible for paying a self-employment tax, which in 2022 stands at 15.3 percent.

That’s all pretty intimidating. Here’s the good news: Freelancers have more deduction options than the typical salaried worker. And some of those deductions can be unusual, to say the least.

There’s nothing wrong with an odd-sounding deduction, but there is a line freelancers have to negotiate. They’ll have to be able to prove the expenses they claim are legitimately related to their profession, or as the IRS prefers to put it, that a deductible business expense "must be both ordinary and necessary."

There’s no one-size fits all for freelancers either when it comes to deductions. A freelance handyman, for example, could write off his or her tools, while a freelance coder or programmer likely wouldn’t be able to deduct a new band saw.

Tax rules for freelancers are complex — often frustratingly so. The IRS has a web page dealing with issues related to self-employed individuals to help make things a bit easier. But to avoid confusion and the increased chance of an audit by the IRS, many contractors and freelancers find it best to consult with a tax professional before making a deduction.

That said, there are some fairly standard deductions for freelancers:

Typical freelancer tax deductions

Home office Freelancers working out of their house can deduct that portion of their mortgage or rent, according to IRS regulations. The hook is the room or area must be used exclusively for work. (In other words, they can’t set up shop in their living room or dining room but have to have a separate, dedicated space.)

Note that if you received a W-2 form from your employer, you’re out of luck. Home office deductions are exclusive to self-employed individuals, meaning even if workers use their spare bedroom as an office, it’s not deductible. If you received a 1099 statement instead of a W2, though, you should be ok.

Utilities As with a home office deduction, freelancers are able to deduct a percentage of their utility bill. That amount can vary depending on how big a percentage of the home's overall footprint is claimed by the home office.

Liability, malpractice Insurance ― The IRS says freelancers can generally can deduct premiums paid for insurance related to the applicable trade or business. This is a boon for those in public-facing professions where it’s necessary to carry insurance against the possibility of a dispute over the quality or result of services rendered.

Health Insurance ― Qualifying freelancers can deduct up to 100 percent of their health insurance costs for themselves and their families. But they need to have made a net profit for the year — and this tax deduction is not available if their spouse's employer offers an insurance plan that potentially covers them.

Other Insurance ― Despite the advisability and even necessity, life insurance and disability insurance aren’t deductible. (Related: Why you need life insurance and disability insurance).

However, the IRS allows deductions for certain types of business overhead insurance that also cover expenses arising from disability. (Related: Disability impact calculator)

Long-term care insurance can also be deductible, along the same lines as basic health insurance.

Travel Freelancers attending a trade show or heading out of town to meet with (or at the direction of) a client, should hang onto their receipts. Transportation and accommodation costs can be deducted, according to the IRS, as can 100 percent of any business meals they purchase from a restaurant (through 2022).

Websites Many freelancers build and host websites to promote their business or service. The domain fees, maintenance costs and any money they pay for the design and programming of that site are typically deductible.

Beyond the standard deductions, freelancers have more leeway to report things that most people wouldn’t consider claiming on their taxes. As mentioned above, the legitimacy of the deduction is extremely dependent on the type of work done. But Corcoran says she has seen everything from planes to pets to even girlfriends deducted on taxes in the past.

Other possible tax deductions

Internet access No matter what the chosen field, it's virtually impossible to do it without an internet connection these days, making this a common tax deduction for many self-employed individuals.

Drones Real estate agents now commonly use drones to take aerial shots of the properties they're listing, making them a legitimate expense.

Bottled water ― Rideshare drivers live and die by their customer ratings, so many like to stock their cars with little extras for their passengers, such as bottled water, gum, or snacks. Since those aren't reimbursed by the company, the drivers can often deduct them.

Gadgets If you’re someone who likes the latest and greatest — and those tech toys are things that can be used as part of your job — you may be able to write those off on your taxes.

The dog While this generally will be a red flag for the IRS, some freelancers (and their accountants) have made convincing arguments that their pet acts as a guard dog to protect business equipment. If successful, this makes Fido — and all of his or her food and other associated costs — a potentially deductible expense at tax time. Just keep the "ordinary and necessary" standard of proof in mind.

"You would need to show that's why you really had the dog and why you're incurring those expenses," said Stephen Kirkland, a CPA and owner of Atlantic Executive Consulting. (Related: The cost of adopting a pet)

Conclusion

Freelancing can provide all sorts of rewards and benefits, both personal and professional. But tax questions and challenges can be significant. And often the answers will depend on particular circumstances.

A financial professional or tax advisor can often provide useful guidance on what may be beneficial.

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This article was originally published in September 2016. It has been updated.

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The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.