Once you have your last estimated tax payment for 2019 taken care of this month (it’s due January 15), it’s time to focus on this year’s freelance tax return. After all, the sooner you get your 2019 taxes filed and out of the way, the sooner you can look forward to any potential refund and moving on to accomplishing your 2020 goals. If you want to be among the first filers, make a note that the IRS plans to start accepting returns on January 27.
To help you get a head start on your freelance tax filing this year, here’s a review of some of the top deductions you may be able to use to trim your taxes:
Without a doubt, the Qualified Business Income (QBI) deduction (which is the 20 percent deduction available for qualifying pass-through businesses such as sole proprietorships, S-corporations and partnerships) is one that every freelancer should beware of because it can mean some serious savings. Freelance businesses are often considered pass-through because the business income is reported and taxed on the owner’s individual tax return
The 20 percent QBI deduction was new last year under tax reform and has since been updated by the IRS. Below are basic rules for the deduction based on the 2020 guidelines from the IRS. Keep in mind that you’ll use the numbers for 2019 to file your taxes this year:
- The deduction does not apply to corporations.
- It is not based on the definition of business income as most of us are used to. Instead, it uses "qualified business income" (QBI) to calculate any deduction to which you may be entitled.
- There is an income-based limitation on the amount of the deduction.
- Some types of businesses, referred to as a Specified Service Trade or Business (SSTB) in the new tax law, are not eligible for the deduction once certain income thresholds are met.
How do these stipulations apply to freelance businesses? Here’s a closer look at the pass-through business deduction based on the 2020 tax rules:
- QBI, from the IRS’ standpoint, is equal to the income you derive from your pass-through business minus any net capital gains or short-term capital losses. In addition, QBI does not include pass-through income from W-2 wages received from an S-corporation or from the guaranteed payments received from a partnership.
The amount you can deduct is also subject to caps of either 50 percent of the wages your business pays its employees or 25 percent of wages plus 2.5 percent of the basis of the business’ qualified property — whichever is higher. These calculations must be compared to the 20 percent of your QBI, then you may deduct whichever amount is less. This limit also phases in over the same $321,400 and $421,400 ($315,000 and $415,000 respectively on your 2019 taxes) taxable income range for joint filers.
- The income-based limitation applies to non-corporate taxpayers who exceed the $321,400 income threshold. If you own a personal service business (called a specified service business), the amount of your QBI is phased out on a pro-rated basis once your total taxable income hits $421,400 ($315,000 and $415,000 respectively on your 2019 taxes). At this income level and above, you no longer qualify for the benefit of the 20 percent deduction. Businesses that are not specific service business are still eligible for the deduction.
- A specific service trade or business defined by the IRS is any trade or business providing services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletic, financial services, brokerage services, and other industries. Also included are any trades or businesses involving investing and investment management, trading, or dealing in securities. Engineers and architects are not defined as a specific service trade or business and thus are excluded from this limitation.
- Businesses that are capital intensive were considered under the new law with an increase in the wage limit to include a qualified property calculation. According to the IRS, qualified property is tangible depreciable property that is used by your business to earn QBI. These deductions can be taken on your individual return and the calculations would apply to each business that you operate separately.
How much this deduction will save you really depends on whether your business is or is not an SSTB as defined above. This is where calculations can get complicated and where talking to a tax professional can help you do the math based on your particular situation.
Some other high-ticket deductions to consider on this year’s return include:
The home office deduction can help freelancers save a significant sum of money every year with just a little more effort than if you used the simplified version of the deduction. Simply calculate the size of the space you use exclusively for business and claim $5 for each square foot (to a maximum of 300) on your tax return. If your home office is large or your associated expenses are higher, you can opt instead for the regular method — which requires you to track your actual expenses such as utilities, mortgage payments, rent, home repairs, home depreciation, etc., and then calculate your deduction based on the percentage of your home devoted to business.
The one important caveat for this deduction is that the space you claim must be used solely and regularly for the purposes of trade or business. This generally applies to a separate room or space in your home that is clearly defined as an office.
The standard deduction often raises the question of whether freelancers are better off itemizing their taxes or not. For many of us, the higher standard deduction that was introduced under tax reform is a better deal unless you have very high medical expenses or other eligible expenses. In 2019 the standard deduction was $24,400 for couples married filing jointly and $12,200 for individuals. In 2020 it is a little sweeter still at $24,800 for couples married filing jointly and $12,400 for individuals.
Business-related meals can really rack up expenses, especially if you take your freelance clients out to lunch, so be sure to gather up all of your receipts and use them to knock down your tax bill. Keep in mind that meal expenses for your business are no longer deductible at 100 percent of the cost (with the exception of office parties, which are still fully deductible). Under the Tax Cuts and Jobs Act (TCJA) the deductions for meal expenses for businesses is now on par with the 50 percent limitation of meal expenses applied to individual taxpayer’s business-related meals. In addition, these amounts incurred and paid after Dec. 31, 2025, will not be deductible at any rate.
The deductions above are just the tip of the iceberg when it comes to what may be available to lower the tax obligation of your freelance business. While the deductions we’ve covered here are some of the largest ones commonly available, it is worth considering which others you qualify for and asking a tax professional for assistance if needed. Taking a look at your tax return now will also ensure that you avoid penalties for late payments and allow you the peace of mind of having your 2019 taxes taken care of early!
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He offers a free consultation to members of Freelancer’s Union* and a monthly email newsletter covering tax, accounting and business issues to freelancers on his website, www.cpaforfreelancers.com — which also features a new blog, how-to articles, and a comprehensive freelance tax guide.
*Jonathan is happy to provide an initial consultation to freelancers. To qualify for a free consultation you must be a member of the Freelancers Union and mention this article upon contacting him. Please note that this offer is not available Jan. 1 through April 18 and covers a general conversation about tax responsibilities of a freelancer and potential deductions. These meetings do not include review of self-prepared documents, review of self-prepared tax returns, or the review of the work of other preparers. The free meeting does not include the preparation or review of quantitative calculations of any sort. He is happy to provide such services but would need to charge an hourly rate for his time.