Tax Deductions for Freelancers and Consultants

Last Updated Mar 16, 2010 5:29 PM EDT

This article is part of a package on tax deductions you can take if you're between jobs and consulting or freelancing while you're looking for work. To find out what you can and can't deduct if you're looking for a job, read our article on deductions for job hunters.



For a club that no one wants to join, it's growing very fast: the Accidental Freelancers Association. More than 27 million U.S. workers, or about one-quarter of the working population, are now operating as sole proprietors, freelancers, or consultants, up from 21 million just five years ago, according to the National Association for the Self Employed. Though joining the AFA can be painful, consider the upside: You get more tax deductions.

In addition to your newfound freedoms — working in your pajamas, avoiding rush hour, never having to deal with HR — there’s a lesser-known bennie to becoming your own boss: Schedule C. That’s a bit of accountant-speak that means every time you whip out your credit card, you may be getting a tax deduction. According to the IRS, you can deduct anything that’s considered “ordinary and necessary” to conduct your specific business. But that’s a very broad definition that may vary widely depending on your industry and how you set up your business. Before using the tax code as justification for succumbing to your iPad lust, check the rules. Here’s a quick guide to some of the major things you can and can’t deduct as a sole proprietor:

Clothing

  • Cannot deduct: That Brooks Brothers suit or Armani ensemble you’ve been eyeing
  • Can deduct: A tuxedo or evening gown
  • It’s quite appropriate that you want to impress potential clients with a wardrobe of well-tailored, clothes. But don’t expect a subsidy from Uncle Sam. The IRS won’t allow you to write off business attire, even if you can prove that you only wear it for work. Arguing that you are expected to look fashionable in your industry won’t fly either. “There’s no way the IRS will go for it, because you can always wear the clothes for other reasons,” says Tina Salandra, CPA and owner of Numerical LLC, an accounting firm in New York City.

    But the IRS has long allowed workers to deduct the cost of purchasing and cleaning work “uniforms,” such as factory jump suits or police dress blues. The catch is that they must be used exclusively for work. Since there are many fewer occasions that call for formal wear outside of business events and parties, tuxedos and evening gowns may be tax deductible. You still have to show that you use them solely for work-related functions, however, according to Salandra.

Memberships

  • Cannot deduct: Gym dues
  • Can deduct: Professional memberships
  • Maybe you need to drop 10 pounds to look better on your sales calls. And what about those networking opportunities in the sauna? But with gym memberships, there’s too much opportunity for non-career related yoga classes and weight lifting sessions to get this past an auditor.

The annual dues for your Harvard Club membership, on the other hand, are easy to sell as a business networking expense. You can also write off memberships to local organizations if you can prove they help you find clients, such as memberships to the local Chamber of Commerce or the Lions Club. These organizations exist to largely provide networking opportunities so they’re easy to justify.

Entertaining

  • Cannot deduct: Annual dues at your country club, season tickets for a luxury suite at Lakers games, summer share in the Hamptons
  • Can deduct: The cost of an individual golf outing at the country club, a single event in your Skybox seats, or entertaining business guests for the day at your summer house
  • Country club dues and similar indulgences were once a favorite write-off for the rich and famous. But the IRS long ago put an end to that practice, explicitly declaring that yachts, summer homes, and season tickets for sports events were not tax-deductible since there’s too much opportunity for non-business related use. You can, however, pro-rate the cost of each individual outing at your country club, or the cost of taking a client to an individual event in your blinged-out Skybox, as long as it’s for networking purposes. Once again, the key is delineating the expense as something solely work-related.

Home Office

  • Cannot deduct: The cost of any portion of your house you use as a home office, if you also use it for any other purpose at any other time
  • Can deduct: The share of your rent or mortgage for a room or portion of a room in your house used solely for work, including storage and meeting space
  • “Whether it’s a separate structure or an existing room in your house, your home office has to be for an exclusive use of business for it to be deductible,” says Mark Luscombe, principal analyst for the tax and accounting group at Riverwoods, Ill.-based CCH. “You can’t use it during the day for business and then let the kids watch TV in there at night.” That means you’ll have a tough time convincing the IRS to let you deduct the cost of your living room, even if you operate a recording studio there during the day. (The kitchen won’t fly, either — laptop or not).

    If you do have space that you use exclusively for work, though, here’s how to deduct it: Multiply the percentage of your home’s total square footage that you’ve dedicated to your work by your rent or mortgage plus maintenance. That’s the amount you can deduct.

Travel Expenses

  • Cannot deduct: Commuting expenses

  • Can deduct: Business travel expenses

  • Getting to and from work is considered a personal expense. However, you can deduct the cost of going from the office — including your home office — to meet a client, purchase business supplies, or conduct research, since the IRS considers these to be necessary business expenses.

    Note: Travel is one of the few expenses that you don’t need receipts for. The IRS will accept a simple travel log, which could be on your Blackberry, iPhone, or a physical notepad. You can write off the costs of subways or the cost of travel expenses and a portion of wear and tear on your car. Or you can take standard mile deductions that cover gas, maintenance on your car, insurance, and depreciation (in 2009 the deduction was 55 cents per mile, but in 2010 it will drop to 50 cents a mile.) You can also write off tolls and parking.

Monthly Bills

  • Cannot deduct: Your full cable TV, Internet, heat, electricity, or telephone bills
  • Can deduct: A percentage of these bills
  • Since the IRS considers these normal expenses that you incur even when you’re not working, they’re not deductible. But if you have a separate, dedicated home office, you can deduct the same percentage of your monthly heating and electricity bills as in the above rent/mortgage example. You may be able to deduct a portion of your cable and Internet bill as well, if you can prove it is work-related. (If you’re in finance, for instance, you could argue that access to CNBC and CBS MoneyWatch.com are necessary business expenses.) You can also deduct individual long-distance business calls, as well as the cost of a second land line or business cell phone if you already have a land line at home. That’s provided you can make the case the second line is used just for business; it won’t fly if it’s for your teenage daughter to spend hours on that phone talking to her boyfriend.


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