Tax Planning for Freelancers: 5 Strategic Moves To Make Now To Avoid Tax Pain Next Year

• Freelancers and contract workers often have access to a range of deductions that can help lower their taxable income.
• If you are a freelancer performing contract work, you may want to consider incorporating as a business.
• For digital nomads, by strategically selecting your base of operations and understanding the tax laws of different countries, you can potentially downsize your tax burden.

It’s the height of summer and many U.S. workers are headed off on vacation for July 4. While celebrating U.S. independence is a good excuse for a summer cookout, it should also be a reminder of the importance of taxes — if you take a long enough break from pool time to consider the actual history of the holiday that is.

While the dust from the 2023 tax filing season has long since settled, if you are a freelance worker, independent contractor, or digital nomad, now isn’t the time to forget about your taxes. The year is (somehow) already half over, so, if you haven’t already started, it’s time to make moves to make sure next year’s tax season isn’t so painful. 

After all, Q2 has now ended and if you don’t yet have a handle on how much you’ve worked or what your tax obligation might be, you and your bank account might be rather miserable come filing time.

An individual who understands their own unique work and life circumstances will find their key sense of self-awareness to be an essential skill when organizing for tax season. Part of that process starts with taking notes on how you work, for how many hours, and from where.

The intricacies of managing your tax information, including all the nuances of making sure you filed your tax information the right way, can feel overwhelming. It’s possible to have missed opportunities in areas where you might have been able to restructure your personal finances. 

However, in a fast-moving post-pandemic workforce, rather than looking at what you could’ve done, it’s better to spend that time preparing for any changes you want to make the next time around. 

If you work as a freelancer or engage in work similar to the 16% of Americans who earned money from an online gig platform in 2021, then there are multiple avenues to explore when bracing for next tax season.

There are five key strategies to enhance your tax planning and preparation: 

1. Consider incorporating yourself as a business
2. Become a digital nomad
3. Keep track of expenses and earnings throughout the year
4. Learn about quarterly payments
5. Understand your eligible tax deductions and credits

By implementing these strategies, you can gain greater control over your finances and maximize your tax benefits.

1. Consider incorporating yourself as a business

If you are a freelancer performing contract work, you may want to consider incorporating as a business. There are multiple ways to incorporate for taxes, but for freelancers the two main paths are: 

• Sole Proprietorship: A sole proprietorship is a business structure in which an individual operates and owns the business as an individual entity. According to the Internal Revenue Service (IRS), “a sole proprietor is someone who owns an unincorporated business by himself or herself.” In this form of business, the freelancer is personally responsible for all aspects of the business, including its debts and legal obligations. There is no legal distinction between the owner and the business.

Freelancers may be interested in a sole proprietorship for several reasons. Firstly, it is the simplest and least expensive form of business to set up and maintain. There are minimal legal requirements and formalities involved, making it accessible for individuals starting out as professional freelancers.

Sole proprietors report their business income and expenses on their personal tax returns, simplifying the tax filing process, and there are fewer ongoing compliance obligations compared to other business structures. 

Additionally, as a sole proprietorship, freelancers have complete control and autonomy over their business decisions and don’t have to consult with partners or shareholders. 

While sole proprietorships provide simplicity and flexibility, freelancers should be aware of potential drawbacks like unlimited personal liability and limited access to certain business benefits and protections. 

• LLC: An LLC, or Limited Liability Company, is an appealing legal business structure for freelancers. An LLC combines different elements from both corporations and partnerships/sole proprietorships to create something new. 

One key advantage that this structure offers to its owners — known as members — is in the name: “limited liability protection.” This means that freelancers who operate as an LLC can separate their personal assets from the company’s debts or legal obligations. In other words, the personal assets of the freelancers that incorporate as an LLC are generally protected, providing an extra layer of financial security. This aspect makes an LLC an attractive option for freelancers seeking to safeguard their personal assets while enjoying the flexibility and autonomy of running their own business.

By establishing a legal entity for your freelance or contract work, you might be able to benefit from various tax advantages, such as Deductible Business Expenses and Pass-Through Taxation.

Seeking guidance from professionals like accountants or attorneys can assist freelancers in making well-informed decisions tailored to their individual circumstances and financial objectives.

2. Become a digital nomad

The rise of remote work and the gig economy has made it possible for freelancers to embrace the lifestyle of a digital nomad. According to a report published by the Pew Research Center, “Roughly three years after the COVID-19 pandemic upended U.S. workplaces, about a third (35%) of workers with jobs that can be done remotely are working from home all the time.” 

As a digital nomad, you have the freedom to work from anywhere in the world, allowing you to explore new places while maintaining your career. This lifestyle choice can also have tax advantages. 

There are three important things to consider: 

• Foreign Earned Income Exclusion (FEIE): Foreign earned income generally refers to the income individuals receive while working in a foreign country. This can include various forms of earnings such as salaries, wages, bonuses, commissions, self-employment income, and professional fees earned by entrepreneurs or self-employed individuals operating internationally.

According to Greenback Expat Tax Services, “The FEIE lets expats and digital nomads exclude a certain amount of foreign-earned income from U.S. taxation.” The income amount varies each year. Greenback Tax Services states that in 2022, the income exclusion was $112,000, and for 2023, the exclusion increased to $120,000.

To qualify for FEIE as a U.S. resident, you must be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

• Foreign Housing Exclusion: In addition to FEIE, the IRS states that individuals who qualify under the bona fide residence test or the physical presence test and have their tax home in a foreign country can also claim an exclusion or deduction for their foreign housing amount.

According to the IRS, “Once you establish bona fide residency in a foreign country for an uninterrupted period that includes an entire tax year, you will qualify as a bona fide resident starting with the date you began the residency and ending with the date you abandon your foreign residence.” 

The housing deduction is applicable solely to amounts paid for with self-employment earnings. To determine your foreign housing amount, subtract the base housing amount from your total foreign housing expenses for the year.

• Foreign Tax Credit: When you have paid or accumulated foreign taxes to a foreign country or U.S. possession and you are also liable for U.S. taxes on the same income, you have the opportunity to potentially claim either a foreign tax credit or an itemized deduction for those foreign taxes.

By strategically selecting your base of operations and understanding the tax laws of different countries, you can potentially downsize your tax burden. Some countries offer favorable tax incentives for foreign residents or digital nomads, in the form of special tax regimes or exemptions. However, navigating international tax regulations can be complex, so it is very important to consult with a tax advisor who specializes in cross-border taxation to ensure compliance and optimize your tax situation.

3. Keep track of expenses and earnings throughout the year

By diligently tracking income, expenses, and relevant receipts, freelancers and contract workers can ensure that they have accurate and comprehensive documentation to support their tax filings. This not only simplifies the task of gathering necessary information during tax season, but also minimizes the risk of missing out on eligible deductions or credits.

Leveraging technology and software tools designed for tax management can make the process run without a hitch. Using digital platforms like Bench and FreshBooks helps facilitate expense tracking, receipt management, and even tax preparation, which can save time and reduce headaches. With automation and integration features, these tools can help freelancers and contract workers stay organized and ensure compliance with tax regulations.

4. Learn about quarterly payments

As a freelancer or contract worker, you may be required to make quarterly estimated tax payments throughout the year. These payments are intended to cover your tax liability and prevent underpayment penalties. 

It is important to understand the rules and deadlines for making these payments to avoid any potential issues. Generally speaking, anyone who expects to owe $1,000 or more on their taxes has to make quarterly payments, according to the IRS. 

By staying proactive and fulfilling your tax obligations on a regular basis, you can avoid surprises and financial strain when the tax season arrives.

5. Understand your eligible tax deductions and credits

Understanding the tax deductions and credits you are eligible for is another key to organizing your tax filing. Freelancers and contract workers often have access to a range of deductions that can help lower their taxable income. 

Some of the common deductions include: 

• Car mileage
• Home office expenses, including office supplies, internet costs and, in some instances, even portions of your rent or mortgage costs
• Professional development and education costs
• Travel costs
• Health Insurance Premiums

Additionally, depending on your circumstances, you may qualify for specific tax credits such as the Earned Income Tax Credit (EITC) or the Self-Employment Tax Deduction. 

Once again, stay informed about the latest tax laws that apply to your own circumstances and consult with a tax professional to ensure you are taking full advantage of all available deductions and credits.