Managing taxes can be one of the most challenging aspects of being a freelancer. Many find it daunting, and it tends to be swept under the rug far too often. The problem here is that over time the dust under the rug turns into an all-consuming monster.
So yes, don’t neglect your taxes, but tax as a freelancer is a complicated topic – not really the kind of thing you want to spend your time worrying about, especially when you’re focusing your time and energy on the things you do best. The services of a tax professional are invaluable, but as a freelancer you owe it to yourself and your business to understand the following fundamental concepts.
PAYE (Pay As You Earn)
PAYE is not just for salaried individuals. Some of your clients may deduct tax on your behalf, just as if you were employed. There’s a key difference though – When salaried, your employer has a very good idea of how much you’ll earn during the year, so they can deduct your tax quite accurately. With freelancers this is impossible, so when tax is deducted from your payment, it’s normally at a rate of 25%. SARS sets the bar at 25%, as a good middle-ground tax rate.
Always keep track of which clients deduct tax on your behalf, and keep track of how much income you’ve earned, before and after tax. Some freelancers tend to have more than enough tax deducted, and get nice big tax rebates after filing their returns. Others are less fortunate, and have to pay in extra tax. It always helps to know which side of the fence you’ll fall on.
Check out the SARS Income Tax Tables.
Once a year, all freelancers are required to submit an annual tax-return. This is where you declare your income and expenses to SARS, for the financial year recently passed. Tax returns can be audited by SARS, and must be as accurate as possible. This is where the services of a tax professional are most important!
The filing season for annual returns normally starts on 1 July every year, and closes towards the end of November. Annual tax returns must be submitted within that window to avoid potential penalties and interest.
On top of filing annual returns once per year, freelancers are also required to submit two provisional returns per year. The 1st provisional tax date is half way though the financial year, at the end of August. The 2nd provisional tax date comes in February, at the close of the financial year.
The provisional returns allow you the opportunity to pay the estimated tax for the year to date, and they are the perfect opportunity to review your tax situation – ensuring you are adequately prepared for anything SARS could throw at you after the financial year end.
Reducing Income Tax
All individual tax-payers have the opportunity to reduce their income tax through contributions towards pension savings (pension funds, provident funds and retirement-annuities), medical aid + out of pocket medical expenses, and donations to charitable organisations. As a freelancer you have a whole other world of tax deductible expenses available to you.
Consider this – if you work at a company for a salary, it’s normally expected that the company covers any of the costs associated with the job. When working for yourself, you don’t have that luxury, and often times you need to spend money in order to make money.
Thankfully, SARS recognises this so they essentially only want to tax your profits, not your gross income before expenses. The simplified rule of thumb is that any expenses, which you incur in the production of current or expected future income, are potentially tax-deductible expenses.
Be aware of the different categories of expenses that factor in to your business, and ideally, keep track of them in spreadsheet or app. If your situation is relatively complex, consider investing in the services of an accountant or book-keeper.
Typical Tax Deductible Expenses
- Web-design/hosting/SEO/IT services
- Depreciation of equipment
- Banking fees
- Finance charges
- Client Entertainment/Networking
- Meeting Costs
There are two common expenses categories that can be a little tricky to deal with, so let’s have a quick look at those:
Many freelancers use their car frequently during the daily running of their business. You may be driving to meet clients, scouting shoot locations, or picking up supplies. This means that everything from petrol, insurance, maintenance, repairs and depreciation on your car are potentially tax deductible. If you use your car regularly for work then this deduction can be a life saver!
The complication here is that SARS doesn’t want you claiming back expenses related to the private usage of your car, so they require a substantiating logbook to be submitted with any travel related claims. A logbook is used to keep record of your business relating driving.
With a completed logbook, it’s possible to determine the total business vs private use of the vehicle. The business use percentage is then applied to your various vehicle related expenses, in order to figure out the tax-deductible portion. Note that regularly driving, to and from a place of office, is considered part of your private mileage.
SARS does not allow travel claims based on estimation, so make sure to keep a logbook if you plan to claim. A valid logbook must contain the following info:
- Odometer reading at the start of the financial year
- Opening reading at the start of every day you drive for business
- Details of each business-related journey – from where, to where, how far and reason for travel.
- Closing reading at the end of every day you drive for business
- Closing reading at the end of the tax year.
For more info, check out what SARS has to say:
Home Office Expenses
The other common but tricky tax deductible expenses, are those related to using a portion of your home as an office.
Let’s say that 15% of the area of your home is taken up by an office space which you use for business – that would imply that 15% of your rent and other associated home costs are potentially tax deductible.
The problem here is that SARS is very strict about home office expenses claims and they will likely request an affidavit from you, stating the measurements and calculations used to determine the home-office portion of your home. On top of that ,you will also need to state that the space is used regularly and exclusively for business, and that you have no other place of office.
To put it simply, if you’re trying to claim tax back for working from your bedroom or lounge sometimes, that’s not going to go down well. Chances are you would have a bedroom or lounge regardless of whether you’re a freelancer or not. On the other hand, if you have to rent a bigger place in order to have office space in your home, that you use regularly, then that is surely a legitimate business related expense.
Some freelancers can qualify for Turnover Tax, which is an alternative to the normal Income Tax system. The Turnover Tax rates are lower but the catch is that you are taxed on your total income (turnover) – you don’t get to deduct all your business-related expenses first. As a result, Turnover Tax may be calculated on a much higher income than traditional income tax. It can work out well for an individual whose business has very little operating costs, but not so well if your profit margins are low.
If you qualify for turnover tax, SARS gives you the right to choose whichever tax system you prefer. The only danger is that once you’ve made the change from one system to the other, you can’t change back for at least 3 years. It’s highly recommended that you consult with a tax professional if you’re considering turnover tax. They’ll help figure out if you qualify, and whether the change is likely to save you tax going forward.
We all deal with VAT every day – it’s the 14% tax that gets added on to the value of most products and services we pay for. If you turnover, or are reasonably expected to turnover at least R1 million worth of taxable supplies in a given tax year, you are obliged to register for VAT. Registering for VAT means that you must add 14% VAT to the cost of your products/services – This is known as output VAT. On the other hand, the VAT you pay as part of your business expenses is known as input VAT.
As a VAT vendor you are then required to periodically submit VAT-returns, and pay SARS the balance of your output VAT, less your input VAT. If your inputs outweigh your outputs you can get some tax paid back to you, but on the flipside, you can also end up owing SARS VAT. This is a very real expense and must not be ignored.
The world of tax, as a freelancer, is so much more complex than I could possibly outline in this blog. Nonetheless, a basic understanding of the concepts outlined above will give you a good overview of what’s expected from you in terms of keeping on top of your taxes.
Remember, you don’t have to face this alone. Due the complexity of the matter, compared to the case of a salaried individual, all freelancers should consult with a trusted tax professional. Whether you’re doing your taxes yourself, or with professional help, you should always be aiming to understand how tax affects your business.
Finally, don’t be afraid to ask questions! A basic tax understanding will not only help minimise the amount of tax you pay, but also help you make informed decisions about your financial goals, and the future of your business.