Being self-employed is one of the most rewarding career choices out there, but it also comes with its own set of challenges—especially when it comes to taxes. If you’re like many entrepreneurs and freelancers, you probably don’t have a dedicated HR department to handle your taxes. This means it’s all on you to keep things in check. Unfortunately, many self-employed workers make some common mistakes that can lead to audits, penalties, or missed opportunities for savings.
Here’s the thing: taxes don’t have to be a nightmare. By understanding the most frequent mistakes and how to avoid them, you can save time, money, and stress. Let’s dive into some of the biggest errors and learn how to steer clear of them.
1. Failing to Track All Business Expenses
It’s easy to forget to track every little business expense when you’re running around meeting clients or managing your workload. But the IRS expects you to keep records of everything, even if it seems small. Deductible expenses include things like office supplies, business meals, travel, and even a portion of your home rent or mortgage if you have a home office.
To make things easier on yourself, get into the habit of using an app or accounting software to track expenses. These tools can help you categorize and organize everything, making it a lot less stressful come tax time. It’s also smart to keep receipts and make notes on any transactions, as you may need these records for deductions or to defend your claims if the IRS comes knocking.
2. Underestimating Quarterly Taxes
As a self-employed person, you’re responsible for paying estimated quarterly taxes—which can be easy to overlook. Unlike salaried employees who have taxes automatically withheld from their paychecks, freelancers and small business owners need to calculate and submit their taxes every quarter. Failing to make quarterly payments can lead to penalties and interest charges.
If you’re unsure about how much to pay, you can use the IRS Form 1040-ES to estimate your quarterly tax liability. It’s always better to overestimate than underestimate, just in case you have a higher income than expected. Setting aside a percentage of your income each month can help you avoid scrambling when it’s time to pay your quarterly taxes.
3. Not Taking Advantage of Tax Deductions
One of the perks of being self-employed is that you get access to numerous tax deductions that salaried workers don’t. These deductions can significantly reduce your taxable income, but many self-employed workers miss out simply because they aren’t aware of them.
Some of the most common deductions include:
- Home office deduction: If you use a part of your home exclusively for business purposes, you can deduct a portion of your rent, mortgage, utilities, and other home-related expenses.
- Self-employment tax: You’re responsible for paying both the employer and employee portion of Social Security and Medicare taxes, but you can deduct half of these taxes from your income.
- Health insurance premiums: If you’re self-employed and pay for your own health insurance, you may be able to deduct the cost of premiums.
- Retirement contributions: Contributions to retirement accounts like a SEP IRA or Solo 401(k) are not only an excellent way to save for the future, but they’re also tax-deductible.
To make sure you’re getting the most out of your deductions, consult a tax professional or use accounting software that can identify potential deductions based on your spending.
4. Mixing Personal and Business Finances
It’s easy to let personal and business finances mingle, especially when you’re just starting out. However, mixing the two can create problems come tax time. Separate business expenses from personal expenses to make record-keeping easier and more accurate. Using separate business accounts for your income and expenses also makes it easier to track profitability and identify trends in your business finances.
Another big benefit? Avoiding audits. The IRS takes a keen interest in self-employed workers who mix their personal and business expenses. Keeping clear, organized financial records is your best defense if you’re ever audited.
5. Forgetting to Deduct Business Mileage
If you drive for business—whether you’re visiting clients, going to meetings, or running errands—you can deduct mileage. In 2023, the standard IRS mileage rate is 65.5 cents per mile. That may not sound like much, but over the course of a year, those miles can add up.
To get the full benefit of this deduction, be sure to track your business miles regularly. You can use an app like MileIQ or Everlance to log your miles, or keep a simple logbook in your car. Just make sure the mileage is clearly for business purposes.
6. Misunderstanding the Self-Employment Tax
Many self-employed individuals fail to realize that, unlike employees, they must pay both the employee and employer portions of Social Security and Medicare taxes. This is referred to as the self-employment tax, and it can come as a shock when it’s time to file. The rate is currently 15.3%, which covers both Social Security (12.4%) and Medicare (2.9%).
While this tax can feel like a heavy burden, there’s a silver lining: you can deduct half of your self-employment tax when you file your return, which helps reduce your taxable income. It’s also important to remember that the self-employment tax only applies to your net income, so your business expenses can reduce this amount.
7. Not Keeping Up with Tax Law Changes
Tax laws are constantly changing, and it’s easy to miss updates that might affect you. For example, tax credits, deduction limits, and rates can shift year-to-year. Staying up to date with these changes ensures you’re not leaving money on the table.
One great way to keep current is to subscribe to updates from the IRS website or follow finance news outlets that cover tax-related issues. Additionally, if you work with a tax professional, they should be on top of any changes that might impact you.
8. Overlooking Tax-Advantaged Accounts
When you’re self-employed, it’s crucial to take advantage of tax-advantaged retirement accounts. Traditional IRAs, SEP IRAs, and Solo 401(k)s allow you to contribute money that grows tax-deferred, meaning you won’t pay taxes on it until you withdraw it in retirement.
If you’re self-employed, these accounts also help reduce your taxable income for the year. For instance, in 2023, you can contribute up to $66,000 to a Solo 401(k) if you’re over 50, which can significantly lower your taxable income. Starting early with contributions can have a major impact on your financial future.
9. Not Setting Aside Enough for Taxes
It’s tempting to take home a large portion of your income when you’re self-employed. But if you don’t set aside a portion for taxes, you might be in for a rude awakening at tax time. A good rule of thumb is to set aside at least 25-30% of your earnings for taxes.
You can use a simple percentage method by setting up a separate tax savings account and depositing a portion of your income every time you receive payment. This way, you won’t be caught off guard when the IRS bill arrives.
10. Filing Late or Not Filing at All
This is a mistake no one should ever make. Filing your taxes late can result in hefty penalties, and in extreme cases, failing to file at all can lead to criminal charges. Even if you can’t pay your full tax bill, it’s better to file your return and set up a payment plan with the IRS than to ignore it completely.
To avoid this mistake, mark important tax deadlines on your calendar and try to get your taxes done well before the due date. If you need an extension, you can file one, but it only extends the deadline for filing, not for paying any taxes owed.
Final Thoughts
Taxes can be one of the most confusing parts of being self-employed, but by avoiding these common mistakes, you can reduce stress and keep more money in your pocket. Staying organized, understanding your deductions, and filing on time will not only save you money but also keep you compliant with the IRS. With the right preparation, taxes don’t have to be a burden—they can be an opportunity to build your business and your wealth.
By paying attention to these details, you’ll be on your way to mastering your finances and avoiding the common traps that many self-employed individuals fall into. Keep learning, stay proactive, and make sure you’re always staying one step ahead of the tax game!