Freelance Finances: The Tax Challenge

    Freelance Finances: The Tax Challenge

    Chris Morris

    Whether you call it “freelance,” “self-employed,” or “contractor”… there are some undeniably great things about working for yourself. You can set your own hours. You have the option of saying "no" to work that doesn't interest you. And casual Friday takes on a whole new meaning.

    Of course there are challenges, not the least of which is making sure you have enough clients and enough work to make freelancing worthwhile for you. But beyond business basics, there are challenges many don’t appreciate until they actually wade into the freelance world.

    One sizable hurdle is putting together your own benefits package in the absence of a corporate human resources department. But another, possibly more formidable task, is meeting the tax requirements.

    A study by researcher Common Cents Lab found that nearly one in five independent contractors were unaware of the basic federal requirement underlying the freelance system: if you expect to make more than $1,000 in a given year, you must file estimated income and taxes every quarter.

    Quarterly taxes are the bane of the freelance world, as Uncle Sam requires the self-employed to pay their estimated taxes on an ongoing basis (mimicking the tax withholding from salaried workers’ paychecks). And, of course, the final summation on April 15 is no joy, either.

    Without a parent company to split the FICA costs, freelancers pay a whopping 15.3 percent self-employment tax1 on top of their state and federal responsibilities, based on their estimated income for the year. (And if they have a better than expected year? They get socked again during the traditional tax season).

    The saving grace for the self-employed is they can consider a few more options than typical salaried workers when it comes to tax deductions.

    But here, too, are some stringent requirements. Independent contractors and freelancers going the deduction route have to be able to prove that those expenses are legitimately related to the profession they've chosen to pursue.

    The Internal Revenue Service doesn't have a specific list of what is and isn't allowed. However, it says, a deductible business expense "must be both ordinary and necessary."2 In other words, it should be both common and helpful or appropriate in their trade or business. And what's good for one freelancer isn't necessarily good for another.

    "A given expense might not be appropriate in one business sector but might be quite appropriate in another," said Eric Smith, a spokesperson for the IRS.

    To be fair, anyone can itemize many of the same things as a self-employed person, but if for those receiving a W-2 each year, their deductible expense must exceed 2 percent of their income and it affects their Alternative Minimum Tax as well, said Stephen Kirkland, a CPA and owner of Atlantic Executive Consulting.

    "Employees that have these sorts of things are not accustomed to deducting them because they learn quickly there's no benefit," he said in an interview.

    The challenge for freelancers is that tax rules are complex — often frustratingly so. The IRS, in the coming weeks, is planning to roll out a new web page dealing with issues related to the “sharing economy” 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.

    Indeed, individual circumstances and the possible repercussions of any tax move are serious enough that consulting a tax professional is the wisest course of action, more often than not. This applies not only to current independent contractors, but also those thinking about making a move into the growing gig-economy.

    There are some fairly standard deductions listed on the IRS website many freelancers consider:

    Home office Freelancers working out of their house can deduct that portion of their mortgage or rent, according to IRS regulations.3 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 space.)

    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.4

    Other Insurance – Life insurance isn’t deductible. Disability income insurance premiums can be deductible, but tax advisors recommend that self-employed people avoid doing it.

    “If any portion of the premiums are ever deducted, then any benefits received later would be taxable,” said Kirkland. “If none of the premiums are deducted, the benefits are received tax free. Since the disability payments would replace only a portion of someone’s income, they would be left with too little if it was taxable.” (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 50 percent of any business meals they consume while on the road.

    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 is typically deductible.

    What Some Freelancers Claim

    Some freelancers can consider some more far-ranging, even offbeat, types of deductions. Indeed, depending on their chosen field, many freelancers could be able to write off expenses that 9-5ers can only dream about.

    But, again, these are deductions that any freelancer would want to consult with a tax professional about before submitting paperwork to the IRS. And it's dependent on the type of work being done. Among the possibilities are:

    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.

    Home improvements Sprucing up a house can be an advantage at tax time for those freelancers operating a home office. Most improvements, including external paint jobs, are eligible, though only for the same percentage amount as the existing home office deduction. However, said Kirkland, any improvements a freelancer makes directly to his or her home office (a new overhead light, for example) are 100 percent deductible.

    Drones More and more real estate agents are using drones to take aerial shots of the properties they're listing.  So some real estate professionals have started listing them as a legitimate expense for their business. (Just don't forget to register the unmanned aircraft with the FAA.)

    The dog This is generally a big red flag for the IRS, but 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 Kirkland.

    (On a side note, if you use your dog as a service animal, the IRS says it can be deducted among your medical expenses.)5

    Movie tickets and DVDs Most actors are contract workers. And, as such, if they can show a legitimate reason they're buying or attending a movie (i.e. they're up for an audition with the director or, perhaps, are studying a certain actor or actress's style), it could be tax deductible. Tax professionals generally advise thespians to save receipts and have an explanation ready for why the expense was "ordinary and necessary."

    New tech toys A quality monitor, digital SLR camera or 4K camcorder doesn't come cheap, but if they're tools a freelancer uses on a regular basis as part of the job, then it could be a possible tax write-off that they’d want to consider.

    "I would absolutely deduct that," said Kirkland, regarding the DSLR for a freelancer using it in the course of regular business. "If it was challenged, my argument would be: My phone is good enough for me taking pictures personally; I need the camera for professional reasons."

    Bottled water Uber 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.

    Gifts Business gifts are also an area some freelancers take advantage of, as they are deductible. Generally, most people view it as a bottle of wine or token of appreciation to clients. Just remember that gifts are limited to $25 per person.

    These are just what some freelancers look at in terms of deductions and they wouldn’t apply to all businesses. Again, how expenses relate to any given business can be subjective and it’s wise to consult a tax professional before making a deduction. But as more people join the growing gig-economy, more people are looking at the possibilities.

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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.

    1 " Self-Employment Tax (Social Security and Medicare Taxes)," June 20, 2016

    2 "Deducting Business Expenses," May 3, 2016

    3 "Home Office Deduction," May 13, 2016

    4 "Publication 535, Business Expenses," Jan. 7, 2016

    5 "Publication 502," 



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