Freelance Business Expenses, Explained
Spending money to operate and expand your business is a natural part of being a successful freelancer. This guide explores the most important aspects of freelance deductions, from basics and tracking, through expense types and splitting expenses, to bookkeeping and taxes.
Your freelance expenses come from the money you spend in your business on your operations, expansion, and other key areas. Legitimate business expenses are deductible from your income for tax purposes, which means that with the same revenue, the higher your expenses, the lower your taxes.
Freelancers need to carefully track and record expenses, and keep enough money in a bank account to pay vendors and suppliers. It’s also important to categorize expenses so you can understand where you’re spending money and correctly complete your tax returns.
This guide explores many aspects of freelance deductions, including an introduction to expense basics, bookkeeping, spending, expense types, splitting between business and personal expenses, categorization, tax forms, challenges, and best practices.
Key takeaways
Freelancers will naturally incur expenses as part of the cost of doing business.
Freelance expenses come in many types and from many sources, depending on where money is being spent.
Legitimate business expenses are deductible from freelance revenue when calculating income and self-employment taxes.
Bookkeeping is essential to recording, tracking, categorizing, and understanding freelance expenses.
Freelancers must correctly report on expenses to claim them for tax deduction purposes.
Read on to find out everything you need to know about your freelance business expenses.
What I will cover in this guide to freelance expenses
This is a very in-depth guide! You’ll find helpful information on several freelance expense areas, including:
The basics of freelance expenses.
Recording and tracking your business spending.
Types of business expenses.
Splitting expenses for personal and business use.
Common obstacles and challenges relating to your freelance expenses.
Important forms and documents for managing expenses.
What your freelance deductions mean for paying taxes and filing tax returns.
Best practices for understanding and staying on top of your expenses.
Before we start, a couple of quick notes.
Firstly, this guide covers what expenses are, and how they are used and tracked. If you're after a specific list of what you can expense as a freelancer, check out the complete list of freelance business expenses.
Secondly, please note that the information in this guide only applies to US-based freelancers, and that I am not an accountant or tax professional. This guide is intended as general information only, and you should always talk to a qualified professional about your unique circumstances. Please see the notice at the end of this guide for more information.
Alright, let’s get into it.
The basics of understanding your freelance expenses
Discover the most important concepts to understand the money going out of your freelance business.
How are freelance business expenses created?
You create a freelance expense when your business spends money as part of its operations, growth, or for other legitimate purposes. This might be money that your business spends directly, from your business bank account, credit card, or as a fee that’s deducted. It might also be an expense that you make from a personal account or card for business purposes, and then claim back from the business.
Where do freelance expenses come from?
You create a freelance expense every time you spend money on a necessary and reasonable cost on behalf of your business. These expenses can come from multiple sources. They can happen directly when you pay for a new computer or monitor to do your work. They might happen indirectly because you use a home office deduction because you freelance from home. Or they might be incidental costs, like fees that you’re charged to process credit card payments.
I’ve created a complete list of common freelance business expenses here.
Why are freelance business expenses important?
Freelance expenses matter for a couple of critical reasons:
You need to spend money to keep your freelance business operational, expand what you do, or otherwise make an improvement.
You get to deduct legitimate expenses from your freelance income to calculate your profits.
You pay self-employment and income taxes on your profits, not your revenue. This means the higher your expenses, the lower your profits—and consequently, the less tax you will pay. This is what’s meant when we say that expenses are “tax deductible.” You get to deduct the expenses so that you don’t pay tax on the money you spend to operate your business.
When do I incur business expenses?
Generally, for a small freelance business, you will incur expenses when you actually spend money, or when money is taken from what is owed to you. This can vary slightly depending on the type of accounting you use, but the easiest way to track spending is to record the expense when it leaves your bank account. This is known as “reconciling your bank account transactions” and it’s an important part of efficient bookkeeping.
Is the money I pay myself a business expense?
Generally, the money that you take out of your business to pay yourself is part of your profits and is not deductible as an expense. You will generally pay self-employment and income taxes on all freelance profits, whether you take them out of your business or not. If you’re taxed as an S Corporation, then the technicalities of this can be different, and you should speak to your accountant for specific information.
How does managing my freelance expenses save me time, effort, and hassle?
The main advantages of managing your freelance expenses are that you will:
Understand what you owe and have paid to others from your business.
Pay vendors and providers promptly and on time, so you can operate and expand.
Have confidence that your expenses are lower than your revenue, so you have enough money to meet your commitments.
Understand your cash flow and roughly how much tax you might need to pay, depending on your sales and expenses.
Report accurate figures for calculating estimated and end-of-year taxes.
Recording and tracking freelance business expenses
What’s the process for spending money and recording expenses?
The exact way that you spend money and record expenses will vary between businesses, but here’s one way it can work:
You decide that you need to spend money on something to operate or expand your freelance business.
You pay for that product or service from your business debit card, credit card, or bank account.
You review your transactions across each of your business accounts during your regular bookkeeping.
You look at each transaction and reconcile each expense against the relevant category in your bookkeeping software.
You examine your bookkeeping P&L report on a regular basis to track your expenses.
You deduct your expenses from your business revenue to calculate your profits.
You pay estimated taxes on your profits through the year.
You capture the relevant expense amounts on your tax from at the end of the year when you’re preparing your tax returns.
How do I track my freelance expenses in my bookkeeping software?
It’s important to record all of your freelance expenses, wherever they come from. You can do this using your freelance bookkeeping system. The way this normally works is:
You connect your bookkeeping system with your freelance accounts, such as your bank account or credit card.
As you spend money, this will create an expense transaction in the relevant account.
The bookkeeping software imports transactions into your bookkeeping software for review.
When you reconcile your bank account transactions, you assign them to default and custom categories in your software.
You repeat this on a regular basis.
If I don’t have bookkeeping software, how do I track my expenses?
If you don’t want the cost or overhead of using bookkeeping software, then you will need to keep a running total of your expenses. In that case, you might want to set up a simple spreadsheet with the expense name, vendor, date incurred, amount paid, category, etc. You can then use that total for your freelance expenses at the end of the year.
Should I categorize my freelance business expenses?
Categorizing your business expenses is a good idea for several reasons:
You can understand the main areas where you’re spending money for your business.
Some tax forms require you to specify the areas where your business is spending money.
It’s helpful to see expenses trends over time so you can track how costs are changing.
Your bookkeeping software will have several preset categories that you can assign expenses to when you’re reconciling your bank account and transactions. You should also be able to add your own categories for a more precise understanding of your spending.
You can typically see your expense categories and how much you’re spending in each on your Profit & Loss (P&L) report in your bookkeeping software.
An example of a P&L report
How do I categorize my business expenses?
Here’s how to categorize the spending you make in your freelance business:
Decide on how you want to categorize your freelance expenses by looking through expense lists and your spending.
Review the current expense categories in your bookkeeping software to see if the default categories meet your needs.
If they don’t meet your needs, create new expense categories in the settings or in the “Chart of Accounts.”
When you reconcile your transactions and bank accounts, assign your expenses to the relevant categories.
Review your expenses and P&L reports on a regular basis, and update your categories as appropriate.
Do I need receipts to claim a business expense?
You should be able to back up any expense claim that you make. You do this through demonstrating you have spent the money using a receipt. This could be a physical receipt, a digital copy, an email from a vendor, or something similar. If you are not able to produce a receipt when asked, the IRS may disallow your expenses claim.
Do I need a separate business bank account to track my freelance expenses?
You are only legally required to have a separate bank account for your business if you formed your business as a Limited Liability Company (LLC) or a corporation. In those cases, you must always have a separate bank account purely dedicated to your business transactions. You would spend money from that account, receive income into it, and use the money in that account to pay yourself.
Even though you do not strictly need a separate business bank account if you’re a sole proprietor or a partnership, it’s often a very good idea. It helps to keep your finances separate, which makes it much easier to understand your freelance expenses, reconcile your bank account, complete your bookkeeping, and work out how much tax you will owe.
How do my freelance expenses work with my bank account?
It’s often a very good idea to have a business bank account dedicated to the money coming into and going out of your business. As you spend money from your bank account, you’ll use your bookkeeping software to reconcile and categorize those transactions against your expenses.
How do I ensure that I track my freelance expenses correctly?
Review your expenses and reports on a regular basis. Go through each of them to ensure that everything adds up. That way, you’ll be confident of your figures when it comes to completing your tax return.
Types of Business Expenses
What are the main types of freelance expenses?
Broadly speaking, freelance expenses tend to fall into one of the following categories. I’ve included a lot more detail on each of these in the complete freelance business expenses guide:
Computing, software, and communications
Home office and working from home
Bank and payment processing charges
Financial services and loan interest
Retirement contributions
Payments to employees (not yourself)
Hiring experts and professionals
Insurance
Some taxes
Education and learning
Freelancing equipment
Marketing and advertising
Vehicles and similar assets
What does the IRS say about business expenses?
The IRS requires that your expenses are “ordinary” and “necessary.”
These are specific terms, and here's what the IRS tells us about “Ordinary” and “Necessary” expenses.
“To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
Here’s some more information:
Ordinary expenses are the types of expenses commonly used by people in your line of work—for you that means providing freelance services.
Necessary expenses are costs that are useful to running your freelance business, and appropriate for their purpose.
Necessary expenses must also be ordinary expenses for you to deduct them.
What do "ordinary" and "necessary" expenses mean for freelance businesses?
Think of these expenses as the money you have to spend to own, manage, and grow your freelance business. In particular:
You’re making an expense that’s normal in your line of work. For a freelancer, this might be something like a home office expense because you have a dedicated space where you do your work.
You’re making an expense that will help you carry out your freelance work. This might be something like paying for a training course or software to make you better at performing freelance services.
If it’s reasonable that any freelancer would claim this as a legitimate expense, and you can back this up with a receipt or similar, you can probably include it in your bookkeeping system and on your tax return.
Does the IRS list examples of "ordinary" and "necessary" expenses?
The IRS specifically says that the following examples of expenses typically qualify as "ordinary" and "necessary."
Employee pay—the wages and salaries that you pay to employees (not yourself) in exchange for providing services to your freelance business.
Retirement plans—contributions that you make to tax-advantaged retirement plans, within certain contribution limits. As a freelance business owner, you can contribute to your own retirement plan and expense this against your business costs.
Rent / home office expense—most freelancers work from home. If this is the case for you, you can expense a proportion of your home costs, subject to certain limitations.
Interest—if you borrowed money for your freelance business, the interest you pay on the loan is deductible.
Taxes—you can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.
Insurance—generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession. For a freelancer, this may be extra insurance costs for running a business from home, or additional insurance like professional liability.
Splitting freelance expenses between business and personal
Some of the money you spend running your freelance business will exclusively be a business cost, but some of your costs may give you a personal benefit in addition to a business one. You can fully deduct legitimate business expenses from your freelance revenue for tax purposes, as you only pay tax on your profits.
But, if a cost benefits both you personally and your freelance business, you need to split that amount into two parts—business and personal, and only deduct the business part for tax purposes.
What does it mean to have freelance expenses that apply both to my business and to me personally?
There are two types of expenses that your freelance business might incur:
Expenses that are only used to run your business and don't have any purpose outside of that—for example, the cost of running your bookkeeping software.
Expenses that help with your freelancing but also give you some personal benefit as well—for example, the cost of broadband that you use both for streaming entertainment content and running your business.
If you spend money on products or services that you use partly in your business and partly in your personal life, you can only deduct the amount of the product or service used in your freelance business.
What are the rules for deducting business and personal expenses for taxes?
Money that you spend that only benefits you, and not your freelance business at all cannot be deducted from your revenue for freelance tax purposes. You may be able to deduct some personal expenses elsewhere on your tax return, and you can talk to your accountant about that.
If an expense only benefits your business (there's no personal benefit), then recording it is very simple—you just enter the type of expense, when you made it, and the total amount into your bookkeeping system, as we discussed above.
If an expense benefits both your freelance business and you personally then it gets a bit more complicated—you need to work out what percentage of the expense benefits your business versus benefitting you personally. You can only expense the percentage of the amount that benefits your freelance business.
What are some examples of expenses that benefit both my freelance business and me personally?
The following expenses often provide a benefit to you outside of the freelance work that you do. You must calculate the percentage of the expense that's related to your business:
Mobile phone purchase and line rental. You probably use your phone for both business purposes like checking and replying to emails or sending invoices, but also for personal ones like interacting with social media or calling friends.
Broadband line rental and usage costs. You likely use your broadband during the day for running your business, and in the evening for streaming or other entertainment.
Repair and maintenance of your home. If you need a repair to your home services like heating, and you partly use those services when you're working, you can expense part of the repair or maintenance costs.
Ultimately, if you get some personal benefit and some business benefit out of an expense, you'll need to split and assign the expense appropriately.
How do I decide what percentage of expenses I should assign to my freelance business?
What you're aiming for here is to be fair and reasonable when it comes to claiming the right amount of expenses for your business. One question you can ask is "Could I justify this to an IRS employee if I needed to?" That's generally good guidance for any aspect of your taxes!
Here are some methods for splitting expenses between personal and business.
Splitting freelance expenses based on the time spent using the product or service
You can use this technique if you pay for something that you use part of the time in your freelance business and part of the time in your personal life. Here's how to use the time method for splitting your freelance expenses:
Add up the total amount of time—both business and personal—that you could spend using the specific product or service. This is your "Total Time."
Add up the total amount of time you spend using the product or service specifically for freelance business purposes. This is your "Business Time."
Divide the "Business Time" by the "Total Time." That's the percentage of the amount that you can claim as a business expense.
For example, you pay for broadband at home, and in the average week the total time you spend using it is 80 hours. You spend 40 hours a week using broadband for business purposes. You can expense 40/80 = 50% for your freelance business. Your broadband bill is $80 a month, so you get to claim 50% of that, or $40 as a freelance business expense.
Myself and my wife are both freelancers and we work from home. Combined, our offices take up around 20% of our home. That means the costs we pay for the home as a whole that also affect our offices are expensed at 20% of the total amount.
For example, if the air conditioning unit needs a repair, and that repair costs $1,000, I would expense 20%, $200 of that as a business expense—because I take advantage of the air conditioning when I am working and it needs to be in a good state of repair. Work out your own percentages for business vs. personal use, and then expense them appropriately.
Splitting freelance expenses based on the amount of your house used when running your freelance business
You can use this technique if you have an expense that benefits the entirety of where you live, but you work from home and run your freelance business from part of that home. Here’s how to do that:
Add up the total amount of space in your home. This is your "Total Space."
Add up the total amount of space you use exclusively to run your freelance business. This is your "Business Space."
Divide the "Business Space" by the "Total Space." That's the percentage of the amount that you can claim as a business expense.
Other ways of splitting your freelance business and personal expenses
You can use similar principles in the "time" and "space" methods as a way of splitting your other expenses between personal and business use. In every case, you want to estimate the amount of the expense used to provide a business benefit versus a personal one and expense accordingly.
How do I show bookkeeping for expenses that are partly business and partly personal?
As usual, you enter business expenses into your bookkeeping system. If an expense benefits you personally and your business, then you only enter the amount that benefits your business. Typically, for these expenses, you'll pay for them out of your personal account and then claim the business amount back from your freelance business. You can do this the other way around, paying for all of it out of the business account, and then assigning some of it as a personal benefit, but this tends to be more awkward and complicated.
Speak to your accountant about how to record and show this in your bookkeeping system and the transactions you need to make. Here's how I tend to handle expenses that are for me personally and my freelance business:
If I incur a cost that I believe will be split between personal and business, I pay for the whole thing out of my personal bank account or on my personal credit card.
I calculate the percentage and amount that’s due as a business expense.
I enter the business amount as an entry in my bookkeeping system as an expense that’s due to me.
I transfer the money from my business account to my personal account to settle the expense.
I reconcile the transaction in my business account against the expenses that are due to me.
This might sound a little complicated, but once you’ve done it a few times, it becomes second nature. I've also found it's one of the best ways to track exactly what my business costs are, which is very helpful if my accountant or the IRS has any questions.
Overcoming challenges and obstacles
Learn about some of the biggest challenges freelancers face when it comes to their expenses.
What are the challenges related to managing freelance expenses?
Some freelancers may have issues with managing their freelance expenses. Here are some of the main challenges and how to overcome them.
Not paying expenses on time
If you don’t pay your vendors and suppliers quickly enough, they may withdraw products and services. That can seriously interrupt your business, so make sure you stay on top of what you owe.
Not being prepared for expenses
You need to have enough money in your bank account to pay what you owe, and understand how much you will need to meet your commitments. Stay on top of your cash flow and retain some money in your bank account to meet your expense needs.
Not keeping receipts if you’re audited
You will need to backup any expense claims that you make. That means retaining receipts, emails, or other notifications of money you’ve spent for your business. If you don’t have a receipt for something, the IRS may disallow the expense claim.
Forgetting to record and reconcile expenses
You get to deduct your expenses for tax purposes, so the more you expense, the lower your taxes. If you forget to deduct, you’ll pay higher taxes. Make sure you reconcile your bank accounts and track your expenses on a regular basis, so you can claim everything you need for tax purposes.
Misreporting your freelance expenses for tax purposes
It’s important that you accurately report your freelance income, expenses, and profits to ensure that you’re properly assessed for taxes and pay what you owe. The IRS uses the amounts that you report on your tax returns and has various methods to check you’re reporting correctly.
If the IRS finds a discrepancy in these amounts, it can request more information from you and assess additional taxes, interest, and penalties. If you inadvertently report an incorrect amount, you will need to file an amended tax return.
Important forms and documents for freelance income
Discover the most important forms, reports, and documents for tracking and understanding your expenses.
What forms, documents, and reports are important for managing my freelance expenses?
There are several vital reports, documents, and forms that you’ll need to understand your freelance expenses, these are:
Receipts: Individual documents that you receive from vendors and suppliers to show payment for products and services.
Freelance platform earnings statements: Notifications and statements that you receive from freelance platforms like Fiverr or Upwork that tell you how much you’ve spent in commission or fees, which are deductible as expenses.
Bank account statements: Statements from your business or personal bank accounts that show where you’ve spent money, so that you can reconcile those transactions against the relevant expenses.
Profit and Loss (P&L) reports: These are reports generated from your bookkeeping software that will show your total expenses and also break that spending down so you categorize it.
Federal and state tax returns: This is where you will report your freelance expenses.
How do I report freelance expenses for tax purposes?
The way that you report your freelance expenses for tax will differ slightly, depending on how your business is classed. For sole proprietors (the default business type) and single-member LLCs, you’ll show your expenses on your Form 1040 Schedule C. Partnerships and multi-member LLCs will show expenses on a Form 1065, and S Corporations will show expenses on a Form 1120-S. You may also need to show your expenses on tax returns for your state. Remember that your tax will be assessed on your freelance profits, which is your revenue less your expenses.
Provided you stay up to date with your bookkeeping, you should be able to get these figures from the P&L report in your bookkeeping software.
Taxes and freelance expenses
Learn how your freelance income affects your taxes and how to report your expenses to the IRS.
Do I pay tax on my freelance expenses?
Freelancers generally pay taxes on their profits. Your profits are your gross income (revenue) less your expenses. This means you won’t pay taxes on your expensed amounts. Instead, you’ll deduct your expenses from your revenue and pay tax on the remainder. The higher your expenses, and the lower your income, the lower your freelance profits—and the tax you will pay on those profits.
How are my freelance expenses reported to the IRS for tax purposes?
You self-report your business expenses by including the amounts on your tax return. You can find out the overall amount from your P&L report in your bookkeeping software, then you enter that into the relevant boxes on the forms you file with the IRS.
If you do not use bookkeeping software or have a P&L report, then you will need to add up all of the expenses you incur when freelancing. You will enter your expenses in various tax forms depending on the legal type of business that you run:
For sole proprietors and single-member LLCs, you will enter your expenses on your Form 1040 Schedule C. You will need to categorize these expenses in various ways and include them in the correct boxes in part 2 onwards.
For a partnership or multi-member LLC, you will report your expenses on a Form 1065. You will need to categorize these expenses in various ways and include them in the correct boxes.
For an S Corporation, you will report income on a Form 1120-S. You will need to categorize these expenses in various ways and include them in the correct boxes.
Your freelance expenses are often described as your “Deductions” on these tax forms. You may also need to enter your expenses on your state tax return. These details do vary between states.
How can I stay compliant with the IRS when reporting my freelance income?
The best way to stay compliant is to make sure you do your bookkeeping regularly, gather together all of your receipts, and accurately report what you spent in the year with all vendors and suppliers. The IRS will also compare your total freelance income to your expenses and profits to ensure everything “looks right,” as they have a lot of data on income, expense ratios, profits, and other areas.
Essentially, as long as you report accurately and have receipts to back up your expense claims, you shouldn’t run into any issues. It’s also important to note that taxes can be complex. If you’re just starting out as a freelancer or don’t have very much income, you may well be able to self-report your taxes using software like TurboTax. But, as you start earning and spending more and your tax situation becomes more complex, it’s definitely worth hiring an accountant to help you understand your taxes and file correctly.
Best practices for effectively managing freelance expenses
Let’s finish with a summary of some best practices you can follow to manage and stay on top of your freelance business expenses:
Record all of your business expenses in one place, no matter where they come from.
Categorize your expenses appropriately to help you understand, track, and report on your spending.
Deduct your expenses from your freelance revenue to calculate profits for tax purposes.
Invest in bookkeeping software to help you track and manage your expenses.
Keep receipts for your business spending so you can verify any claims.
Track the proportion of expenses that you share between business and personal use so that you can expense the business part appropriately.
Open up a separate business bank account to make it easier to track the expenses going out of your business.
Reconcile your bank account and spending regularly to stay on top of your expenses.
Regularly review your bookkeeping and Profit and Loss reports to understand your spending.
Keep enough spare money and cash flow in your bank account, especially for paying expenses and estimated taxes.
Report all of your freelance expenses correctly for tax purposes.
See our freelance guides on related topics
Accounting and Bookkeeping: Accounting, taxes, and bookkeeping for freelancers.
Business Expenses: Common costs and expenses for businesses and the rules around bookkeeping.
Revenue and Income: Understanding the revenue that’s coming into your business, bookkeeping, and similar topics.
I am not a qualified professional and I do not provide tax, legal, accounting, or similar advice. These guides are provided for informational purposes only. Always consult with a qualified professional on your unique circumstances. You can find more information in my disclaimer.
By Paul Maplesden