Another year, another change in tax regulations. First, we’ll give a refresher of the tax documents you’ll need to be familiar with. Some of this is a repeat of last year (and is the same every year), so if you’re up to speed on all of that, skip to the end where we’ll talk about the policies that are specific to 2021.
One big thing to be aware of this year, the IRS is going to be very busy. Anything that requires human interaction – like filing a paper return or asking for your tax return via check – is going to be very slow. In January, the IRS said its processing of supplementary forms and documents was taking at least 60 days. Talking to someone at the agency is going to be just as difficult. Expect long wait times, if you can even get in touch with anyone at all.
Overview of the Tax Documents
Form 1040 – The main tax document that everyone fills out is called a Form 1040. This is the tax form headquarters and it serves as the center of all the forms and attachments. In 2018, the IRS shortened the Form 1040 to make it simpler. As a result, it moved a lot of the information that was previously contained on the Form 1040 to different schedules. Now, you’ll likely file a Form 1040 with some, or all, of these different schedules attached.
Schedule C – Freelancers, people with a side business, or anyone who works for themselves (unless you have an S-Corp) will have to fill out a Schedule C with their taxes, which is used to report that business income. After it’s filled out, you’ll attach the Schedule C to your Form 1040. 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. This is one of your most important forms, as you can take a lot of business deductions here!
- Quick Nuance for S-Corps – The IRS views corporations as their own living, breathing, taxable entity. This is different from a single-member LLC or a sole-proprietorship which most freelancers use, as the IRS considers these “disregarded entities” (meaning these entities are just pass-throughs where the owner is responsible for the taxes). If you have an S-Corp, you’ll have to file a Form 1120-S corporate tax return. The income from this corporation will be distributed to the owner of the S-Corp (you) on a Schedule K-1, which you’ll report on your Form 1040. So in this case, you don’t actually fill out a Schedule C to report your business income. Your corporation has to file it’s own tax return on the Form 1120-S instead.
Schedule SE – The Schedule SE (self-employed) will need to be filed to calculate your self-employment taxes. You’ll pay them on the “other taxes” section of your Form 1040. We will go through an example later in this post.
Schedule 1 – If you’re self-employed you’ll also likely need to file a Schedule 1. Schedule 1 has two parts – the first part is for claiming certain types of income that are not on your Form 1040 (Form 1040 only collects information for the most common types of income; so if you sold a business, for example, you’d need to claim the income from the sale on Schedule 1). Part 2 of Schedule 1 is where you can file adjustments to your income. Most self-employed people will want to take deductions here. This is where you can deduct contributions to a Health Spending Account (HSA), the deductible portion of Self-Employment taxes, contributions to an IRA or other retirement savings vehicle, up to $2,500 of student loan interest, and up to $4,000 of higher education tuition, among other things.
Schedule 3 – If you’re claiming any tax credits you’ll need to file a Schedule 3. In 2021, there is an expanded Child Tax Credit (discussed later) so if you have any children you’ll likely need this form. There is also the Earned Income Tax Credit for families with less than $57,414 of income (it depends on a number of factors but if your income is lower this year it is worth checking your eligibility), and the American Opportunity Tax Credit for tax paying students or their parents, among others.
Schedule A – If you choose to itemize your expenses (mortgage interest, property taxes, medical or dental expenses over a certain amount, and charitable contributions) you will do so on Schedule A. Everyone has to choose between taking the Standard Deduction ($12,550 for single filers and $25,100 for joint filers in 2021) or itemizing your deductions. If your itemized expenses are greater than the Standard Deduction, then you should itemize. If not, you should take the Standard Deduction.
Once you’ve filled out all these forms, you’ll be able to calculate your Aggregate Gross Income or AGI. From there you’ll take the standard deduction (or if you itemize your deductions, you’ll reduce your AGI by the itemized deduction from Schedule A) to arrive at your taxable income. The distinction between the AGI and taxable income can be an important one, as we’ll see when we go into 2021 specific tax policy.
Extra Emphasis on Schedule C!
As a self-employed person, one of the biggest benefits is that you get to deduct a wide variety of work-related expenses from your taxes. This is a luxury usually only afforded to wealthy business owners. It is a huge source of savings that you absolutely need to be taking advantage of (and that’s why it’s so important to keep track of your expenses).
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 or Path
- 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 traveling for work
- licenses (i.e. cosmetology license)
- advertising expenses
- client gifts
- affiliate commissions
- accounting services
- and legal services, among others!
An Overview of Some Other Common Deductions
We won’t go too deep on this topic here, but as we mentioned previously, 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 that can be deducted for self-employed workers on Schedule 1
- Retirement savings made to a qualified plan on Schedule 1
- Student loan tax deduction on Schedule 1 — 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 (we have more details in the app).
Self Employment Tax Example
For ease of math, let’s say that you had $100k of self-employment income on your Schedule C. The self-employment tax has two parts: 12.4% for social security (up to $142.8k of income in 2021) and 2.9% for medicare (on all income), for a combined 15.3%. 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 from Schedule C x 15.3% / 2 = $7,650, which you subtract from $100k to get $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 payable 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 Schedule 1 Part 2 (you’ll see this deduction on Line 13 of Form SE and it will flow through to the Form 1040 via Schedule 1). 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.
Note that if your income is above $142,800 the self-employed tax will actually be lower on every dollar you earn above that threshold. This is because the Medicare tax applies to all income, but the 12.4% Social Security tax is only on the first $142,800 of income.
Two Additional Things to Check
Two things you should be sure to ask your accountant about (the latter only applies if you took the deferral in 2020):
199A Tax Break for self-employed workers earning under $165k ($329k for married couples) As part of the 2017 tax overhaul, there was a new 20% deduction available to self-employed workers making under $164,900 for single filers and $329,800 for married couples filing jointly in 2021. 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 had to be paid back 50% by December 31, 2021 and the remaining 50% by December 31, 2022. If you needed some extra cash to help get through the initial impacts of Covid-19, this helped keep some money in your pocket. If you took advantage of it, now you unfortunately have to start paying it back.
New Changes for 2021
If you followed our social media accounts we gave a tip prior to year end that said, if your AGI is close to $150k, get it below that threshold by making a contribution to your retirement plan, HSA, or flexible spending account. As we mentioned above, the distinction between the AGI and taxable income can be an important one. For this year, if a couples’ AGI was below $150k ($75k for individuals) they were eligible for $1,400 of stimulus payments for each member of a household. If you’re just above the $150k (or $75k if single) threshold, you could have reduced your AGI by making pretax contributions to a 401(k), SEP IRA, HSA, or flexible spending account for 2021. Notably, itemized deductions for things like charitable contributions, mortgage interest, state taxes, and other items on your Schedule A won’t reduce your AGI (just your taxable income).
For 2021, there is also an additional $1,600 credit per child under 6 years old (increased from $2,000 to $3,600) and an additional $1,000 credit per child under 18 years old (increased from $2,000 to $3,000 and included 17 year olds) that starts phasing out at $150k of AGI for joint filers ($75k for singles, and $112.5k for heads of households). The government paid 50% of this childcare stimulus out in 2021. Both of these stimulus payments were based off of your income in the prior year – so if your income went up in 2021 and put you over the threshold, you’ll have to pay this money back. If your income was above the thresholds in 2020 but is lower in 2021, you likely never got the stimulus checks so you could see some savings in your taxes this year!
That’s all for 2021. Good luck with your taxes and as always if we can help on anything don’t hesitate to reach out to us at firstname.lastname@example.org.