Memo - 3 Tax Mistakes Costing Freelancers And Small Business Owners $5,000+ Per Year

Many freelancers and small business owners inadvertently overpay taxes each year because they have not received the proper guidance on the different strategies they are able to utilize. Based on what I’ve seen in my professional career, the three mistakes below account for the majority of unnecessary tax exposure among independent professionals. Each is correctable with proper planning and typically results in material tax savings.

1. Operating Without a Tax-Optimized Entity Structure

Most freelancers and small business owners operate as sole proprietors by default and file a Schedule C on their personal 1040 tax return. While this business structure is generally the simplest way of filing your business income and expenses, this structure often produces the highest possible tax burden.

The reason why operating this way may not be the most efficient way to save tax is that 100% of your net business income is subject to Federal income tax, state income tax (depending on the state you live in), and the unfamiliar self employment tax. 

Self-employment tax is a 15.3% federal tax primarily consisting of Social Security and Medicare taxes for individuals who work for themselves. That means every dollar earned after expenses is taxed at 15.3% on those earnings. This is on top of Federal & state income tax. 

This means someone living in a state with a higher income tax rate like CA, NY or NJ making $100,000 of net business income would potentially pay 30%, or $30,000, in tax for the year. Leaving only $70,000 of net earnings in after tax profit. 

Luckily, there are strategies that can greatly reduce this tax burden if implemented properly. 

One of the best solutions for freelancers and small business owners is converting their business to an S Corporation. 

The primary advantage of converting to an S Corp is the ability to reduce self-employment tax. Instead of the full net business income of $100,000 being subject to the 15.3% self-employment tax, a portion of the business income would be paid to the business owner as a reasonable wage on a W2, which would be subject to the 15.3% FICA tax. Then the remaining business income would flow through as dividend income on your personal tax return, which is not subject to the 15.3% self-employment tax. 

This tax strategy could potentially save thousands of dollars in FICA tax each year.

2. Misclassifying Personal Expenses as Non-Deductible

In my experience, freelancers and small business owners under-claim legitimate business deductions due to being too conservative, unaware of what can be deducted, or incorrect categorization.

One of the most common missed deductions is the home office deduction. Every freelancer and small business owner has a home office for business purposes, whether they think they do or not. 

Do you take calls from clients when you are home? Do you plan your next work day when you are home? 

You are likely eligible for a home office expense. 

The IRS even offers a Safe Harbor home office deduction, where you can deduct a flat $5 per square foot of your qualified home office space up to $1,500. This could save you hundreds in tax each year. 

Other common deductions that are often missed are items like software and subscriptions. An expense like an Amazon Prime membership is generally viewed by business owners as a personal expense because the majority of the time is used for buying personal items. But if the Amazon Prime subscription is used for business purposes, like buying office supplies or new monitors, the subscription would be a business expense against your business income provided it is an ordinary and necessary expense for your business operations. 

The main expenses I see missed by the majority of freelancers and small business owners is your cellphone and internet expenses. 

Do you need a cell phone and internet to successfully operate your business? If yes, this would be a valid business for you. 

Finally, I often see my freelancers and small business owners clients commingling their business and personal bank accounts. This is a great way for valid business expenses to be excluded under audit. 

If the IRS sees the majority of business expenses being paid from a personal bank account and not a separate business account, they would often deem the expense to be personal rather than business. 

The best way to negate this issue is to open up a separate bank account, even if the account is in your name, just for business income and expenses.

3. No Quarterly Tax Planning or Cash Flow Strategy

Many freelancers and small business owners operate reactively: earn income first, discover tax liability later.

This results in underpaying tax throughout the year and being subject to unnecessary underpayment of tax penalties from the IRS and state agencies, costing thousands of dollars. 

As a freelancer or small business owner, it is required to  pay your Federal and state tax on a quarterly basis based on projected income for the year. 

These payments are due on April 15th, June 15th, September 15th, and January 15th of each year. 

It is a difficult calculation for most business owners to know how much tax should be remitted each quarter, so please seek advice from a tax professional on what to pay each quarter.

On top of paying quarterly taxes, there are great retirement plan contributions that can be made as a self-employed person which results in great savings in Federal tax.

Plans like a SEP IRA or Solo 401(k) are available to self employed business owners that allow contributions up to $70,000, based on your net self employment income, in 2025 towards your retirement while saving up to $25,000 in tax. 

This means that if one may qualify to make the $70,000 max SEP IRA or Solo 401(k) contribution, it would only cost $45,000 in real dollars to put away $70,000. 

$70,000 contribution - $25,000 tax savings = $45,000 out of pocket towards your future. 

If you have any questions about setting up the right retirement plan for you, please contact a trusted wealth advisor or CFP. If you would like one recommended to you, please contact me. I have some great wealth advisors I work with to help get you set up with the right plan. 

As it has been shown, taxation is not just about compliance it is about design. Most overpayment of tax stems from having a default business structure, reactive behavior, and lack of professional tax planning. 

It is imperative to have the right entity structure for your business and tax planning in place that best suits your unique tax circumstance.  

No business owner should unnecessarily overpay tax if the right plan is put in place. 

If you would like to request my Freelancer Tax Efficiency Review, please contact me at (732) 804-4289 or chettookercpa@gmail.com for a free consultation.