Doing your taxes is a painful task in any year. However, with the Tax Cuts and Jobs Act of 2017 and the CARES Act of 2020 lately it feels like there have been more moving parts than usual. The good news is that some of these changes may be to your benefit! We’ll give you a brief refresher on your tax documents, and then discuss some things that you may be able to benefit from on your 2020 tax return.
An Overview of the Documents
Freelancers, people with a side business, or anyone who works for themselves will likely have to fill out a Schedule C with their taxes, which is used to report that business income. You will fill out the Schedule C and attach it to your Form 1040, which is the standard federal income tax form. There are some exceptions to this — for example, if your business is farming you’d fill out a Schedule F instead of a Schedule C, if it involves rental income or royalties you’d fill out Schedule E. Most people will use a Schedule C though.
If you’re self employed you’ll also likely need to file a Schedule 1. This is where you’ll deduct your health insurance expenses and retirement contributions, among other things. There is also the Schedule SE (self employed) which you’ll need to file to calculate your self employment taxes (you’ll pay them on the “other taxes” section of your 1040). If you’re claiming any tax credits you’ll need to file a Schedule 3. If you choose to itemize your expenses, you will do so on Schedule A.
Schedule C Deductions
You should deduct every business expense that you can on your Schedule C. Some common ones include: electronics used for work, office supplies, subscriptions to software like Photoshop, office furniture, web design expenses, business set up expenses (i.e. if you set up an S-Corp), professional development courses, books and other educational materials, a portion of your rent/insurance if you work from home (or the lease on your office or co-working space), a portion of your mobile phone bill if it’s used for work, a portion of your internet and utility bills if you work from home, transaction fees from companies like PayPal, a portion of your vehicle depreciation/expenses if you drive your car for work and other auto expenses, hotel expenses for business travel, food expenses when travelling for work, licenses (i.e. cosmetology license), advertising expenses, client gifts, affiliate commissions, state and local taxes, federal unemployment taxes, accounting services, and legal services, among others!
We won’t go too deep on this topic here, but everyone has to decide if they want to take the standard deduction or itemized deductions on their Form 1040.
In addition to the itemized deductions or standard deduction, here are some of the most common deductions available to freelancers:
- Employer-equivalent portion of your self-employed taxes (we’ll go through an example of this below as it flows through a few sections of your taxes, whereas the rest of these deductions are primarily taken on Schedule 1)
- Healthcare premiums and some other healthcare expenses that can be deducted
- Retirement savings made to a qualified plan
- Student loan tax deduction — You can deduct up to $2,500 a year of student loan interest from your taxes
Note that to qualify for the healthcare premium deduction, you must not be eligible for an employer sponsored plan (either yours or your spouses). If you meet that criteria, you can only deduct as much as you have in business income on your Schedule C. There are other health care expense deductions available as well, but they’re outside of the scope of this article.
Self Employment Tax Example
For ease of math, let’s say that you had $100k of self-employment income on your Schedule C. When figuring out the self-employment tax that you’ll owe on your Form SE, you get to reduce the self-employment income by half of the self-employment tax rate. So in our example, the taxable income is $92,350 ($100k x 15.3% / 2 = $92,350). Then you apply the 15.3% tax to the $92,350, to arrive at a self-employment tax of $14,129.55. By paying the 15.3% on $92,350 versus the full $100k, this deduction saves you $1,170.45 in taxes. The $14,129.55 of SE taxes would then go to the “other taxes” section of your Form 1040.
There is one more deduction though! You can claim 50% of what you paid as self-employment tax as an adjustment to income on your Form 1040. So our $14,129.55 x 50% = a $7,064.78 deduction to our aggregate gross income, and reduces what you have to pay income taxes on.
Two Additional Things to Check
Two things you should be sure to ask your accountant about (the latter only if you need the extra money in the near term, as you’ll have to pay it back in 2021 and 2022):
199A Tax Break for self-employed workers earning under $167k ($321,400 for married couples) As part of the 2017 tax overhaul, there was a new 20% deduction available to self-employed workers making under $163,300 for single filers and $326,600 for married couples filing jointly. If you’re under those earning limits, the definition of Qualified Business Income is fairly broad so be sure to ask your tax advisor if you’re eligible as it could provide significant savings. For example, if you had $100k of income this 20% deduction would give you an additional $20k of deductions, which at a 35% tax rate results in $7k of savings. There are some caveats to this, mainly that your qualified business income cannot exceed your taxable income (so in our prior example, if you and your spouse took the $24k standard deduction and your spouse didn’t earn any income, then $100k — $24k = $76k of taxable income; so you’d have to cap your 20% deduction on the $76k of taxable income instead of the full $100k of business income).
CARES Act Self-Employment Deferral for 2020 — Section 2302 of the Cares Act made changes that allowed self-employed people to defer 50% of the social security tax on their net earnings from March 27, 2020 to December 31, 2020. They refer to this as the “payroll tax deferral period”. 12.4% of your taxes go to Social Security, so this 50% deduction is equivalent to 6.2% of your earnings.
The tax return deferral must be paid back 50% by December 31, 2021 and the remaining 50% by December 31, 2022. If you need some extra cash to help get through the impacts of Covid-19, this will keep some money in your pocket in the short term. Just be aware that you’ll have to pay it back in subsequent years.