If you earned any freelance income this year — whether you added a side gig to supplement your salary, did some freelance work after losing your job or decided to start your own business — you have access to a lot of special tax breaks. But many freelancers miss out on tax-saving opportunities because they don’t realize they’re eligible for these benefits. And the rules can be tricky because employees can no longer deduct unreimbursed business expenses, but self-employed people still can.
“Most people lose deductions because they simply do not keep records,” says Mackey McNeill, a certified public accountant and financial planner in Bellevue, Kentucky, and Consumer Financial Education Advocate for the American Institute of CPAs. “It’s easy to simply scan and save your deductible receipts.”
You’ll usually need to file Schedule C to report freelance or self-employed income, but you can also deduct many of your expenses. Don’t miss out on the following tax benefits if you had any freelance income this year.
Extra Tax-Advantaged Savings Opportunities
You can benefit from a tax-advantaged retirement savings plan even if you just have a little income from freelancing. Your two main options are a simplified employee pension or a solo 401(k).
A SEP is easiest: It’s offered by most brokerage firms, banks and other financial institutions that offer IRAs. Freelancers can contribute up to about 20% of their net income from self-employment, up to a maximum of $57,000 in 2020. Your contributions are tax-deductible, and the money grows tax-deferred in the account until it’s withdrawn.
But you may be able to save more in a solo 401(k). You can contribute up to 100% of your self-employed income, with a $19,500 maximum in 2020 (or $26,000 if 50 or older). If you earn more than that, you can also contribute about 20% of your net income from self-employment, as long as your total contributions don’t exceed the $57,000 limit (or $63,500 if 50 or older).
A solo 401(k) also gives you an opportunity to build tax-free savings that you don’t have with a SEP. Your solo 401(k) contributions can either be tax-deductible, which reduce your taxable income now but will be taxable when withdrawn, or you can make Roth solo 401(k) contributions, which don’t reduce your taxable income now but are tax-free when withdrawn. (SEPs don’t offer Roth contributions.)
If you lost your job or are starting your own business and your income-tax rate is lower than usual this year, you’ll probably be better off making Roth contributions to the solo 401(k) and building up tax-free income for the future. “Plus, tax rates are super low now, so why take a deduction today when you could gain a lot of nontaxable income over your lifetime?” says McNeill.
In 2020, you can only make Roth contributions for up to $19,500 (or $26,000 if 50 or older) to the solo 401(k). Any additional solo 401(k) contributions are tax-deductible instead.
If you have a side gig in addition to a full-time job, any contributions you make to your employer’s 401(k) reduces the $19,500 (or $26,000) limit you can contribute to the solo 401(k). But that doesn’t affect the contributions you can make based on 20% of your net income from self-employment up to the $57,000 limit.
Not all administrators offer a Roth version of the solo 401(k). Also, some administrators let you take loans from a solo 401(k) and consolidate previous employers’ 401(k) balances into your solo 401(k) plan, says James Brewer, a certified financial planner and CEO of Envision Wealth Planning in Chicago. He works with a third-party administrator that offers extra benefits, such as solo 401(k) loans.
Home Office Tax Break
If you use a space in your home “regularly and exclusively” for business, then you may be able to take the home office deduction — even if your freelance job is a side gig. It doesn’t need to be a separate room, but it does need to be a desk or a corner of a room where you don’t do anything else.
One option is to deduct your actual expenses for the part of your home you use as a home office, based on the percentage of the total square footage of your home. If your home office is 1/10 th of your home, for example, then you can deduct 10% of your rent or mortgage interest, homeowners or renters insurance, electric, water and gas bills as a home-office expense. You can also deduct a portion of your property taxes and depreciation on the home. And you can deduct 100% of some expenses that are specifically for your home office, such as the cost of repairs in that room.
Or you can use the simplified option to calculate your deduction, which is a lot easier. Instead of deducting a portion of all of your expenses (and having to keep all of those records), you can deduct $5 per square foot of your home office, up to 300 square feet, for a maximum deduction of $1,500.
If you’re only self-employed and working from home for a few months, you may be able to take a partial-year home office deduction. “If you worked at home for three months, you could take 25% of $1,500, or $375,” says McNeill. “Remember, the exclusive use test must be met first.” During that time, you need to use that part of your home exclusively for the business.
You may also be able to deduct extra insurance costs specifically for your business. “An often-missed deduction when people work from home is additional insurance — such as a rider for the additional liability or property risk,” says McNeill. “This is deductible in addition to the simplified method.”
Deduct Your Computer and Other Business Equipment
You can deduct the cost of equipment you buy for your business, which can include a computer, printer, desk, chair, filing cabinets, software programs you use for work, printer cartridges and office supplies. “Also, other items such as the ring light you bought to look better on Zoom calls,” says Michelle Morris, a certified financial planner and enrolled agent with BRIO Financial Planning in Quincy, Massachusetts.
“If you purchase a computer for the purpose of freelancing, it is deductible,” says Morris. “If you purchase a computer and use it partly for freelancing and partly for personal use, you can prorate the cost.”
Deduct Other Business Expenses
You can deduct 57.5 cents per mile for business-related driving in 2020, such as driving to visit clients, attend meetings and even to pick up office supplies, says McNeill. You can also deduct parking fees and tolls. Commuting costs, however, are not deductible.
You need to keep a log of your mileage in your tax records. Morris uses the Everlance app, which makes it easy to keep track of business versus non-business mileage and creates a spreadsheet you can export to your tax preparer.
You can also deduct the cost of advertising, mailing, business phone, website design and management, business travel and other expenses. See the IRS’ Self-Employed Individuals Tax Center for more information.
Deduct Classes, Subscriptions and Professionals
The cost of professional development and other classes you take to improve your business skills can be tax-deductible — which a lot of people are doing now to improve their job prospects if they’re growing their freelance business or looking for full-time work.
You can also deduct the cost of professional association dues, networking meetings (even the cost of conferences on Zoom), subscriptions to publications you read for your business, books and other resources.
And the cost of hiring an accountant, lawyer or other professional to help with your business is also tax-deductible. “If you have a coach to help you with your business, that’s a deductible expense, too” says McNeill.
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