Work as a Freelancer? These Tips Could Save Thousands on Taxes

• Author: Mary Singleton
• Posted: 2024-11-02

In the United States, a freelancer is anyone who has to file a 1099 tax form at the end of the year. The key difference between this and the standard W-2 form is that a 1099 worker is called an "independent contractor" and must pay double taxes in Social Security and Medicaid. Though tax reforms have introduced new ways to combat this increase, such as the "Qualified Business Income" exemption, freelance workers are often stuck with a tax bill much higher than they expected.

Here is what you need to know to avoid getting a huge surprise tax bill!

Set Aside Tax Money

Freelancers typically get paid exactly what they're owed for their services. Unlike traditional workplaces, absolutely nothing is withheld. While this can look like easy money, unfortunately most freelancers do not pay quarterly taxes as the IRS requests. Failing to do this will add 3 percent of the taxes you owed quarterly as a form of "interest" to the IRS. This amount may be acceptable in exchange for not having the hassle of filing quarterly taxes.

However, especially for higher-earning freelancers, this can be a lifesaver. It's also more responsible and can paint a more realistic financial picture for you over time.

Make Sure to Claim All Deductions

The standard deduction for traditional office workers is a pretty easy choice, since most people don't have more than $12,400 (for the 2020 tax year) to deduct. Freelancers are also given this personal deduction, but it doesn't cut down on those Social Security and Medicare taxes.

The game completely changes for 1099 workers in terms of deductions available. For example, you can deduct the cost of renting an office or having an office in your home, as long as it's enclosed and almost only used for your business. You have a higher chance of being audited by the IRS if you claim that a room in your home is your personal office.

Travel is also another commonly missed deduction. The standard rate for tax year 2020 is 58.5 cents per mile driven. Tolls, parking fees, and more are also fully deductible as long as the purpose of travel is for business. It can be difficult to keep track of miles, but there are apps out there that you can use to track your mileage.

Your health insurance premiums are also fully deductible. Just as if you were at work and had money taken out of your paycheck before taxes for health insurance, these premiums are deductible. They work on the same premise, but their costs can be higher since an employer won't be subsidizing them.

One deduction that does not exist any longer is the "entertainment" deduction. This included being able to deduct expenses at fancy restaurants where you meet clients and more. The IRS determined that this was being abused to such an extent that it needed to be shut down.

Don't Double-Tax Yourself!

Remember, for the 2020 tax year, the "QBI exemption is in effect". The IRS has published details on what qualifies and what doesn't, but most "sole proprietors" or 1099 workers do qualify. Essentially, you take 20 percent of your gross income and then remove it from taxable income. This removes federal income tax, Social Security, and Medicare tax on that amount of money. Remember to thoroughly research limits on this before using it.

The SALT deduction is another one that can help freelancers. Also called the "Sales and Local Taxes" deduction, it gives freelancers a choice. They can either deduct state income tax or state property and sales tax. Of course, several states have no income tax at all, so the obvious choice would be the property and sales tax portion. However, residents of states with higher income taxes usually take advantage of the income tax piece.

A critical change to the SALT deduction is that a cap has been placed on it. It's moved around drastically as the IRS has tried to find a reasonable spot for it. For the 2020 tax year, the SALT cap is set at $10,000. Efforts to repeal it have been unsuccessful, much to the chagrin of high earners in expensive states.

Dealing with "Self-Employment Tax"

It seems paradoxical for self-employed people to pay more tax than those who are not. However, with some cleverness and thought put into the process, many people can legally dodge a good amount of tax payments.