The logic of taxes when you're a freelancer

by Kirill A. Korinsky

Compared to personal income, paying taxes as a freelancer could be very attractive. Why? You’ve opened the door to pay less, thanks to all the various schemes available. With a bit of careful planning, depending on how you sell your services, this could be very easy. It might also get very complicated.

To start with, you have several ways to pay yourself: dividends, salary, dividends and salary, or register as a sole-trader. Simplified, this could be described as:

  • You sell your services under your name
  • You set up a company which sells your services

Usually, taxes are paid from your profit, not turnover. You should track all the expenses to calculate what you’ve spent and how much you’ve earned during the year. Then you calculate your profit so you can pay taxes. You can also refund yourself in case you prepaid taxes from an estimated profit but the year hasn’t gone as well as you planned.

So which expenses are work related? This is an interesting topic. To keep it simple, everything that is required for work. Examples? In case you need a computer, it is definitely a work-related expense. Tea and coffee? Usually, it is. Espresso machine? It depends on but usually it could be. As well as a coffee cup! Don’t forget to include that part of your home which you use as an office, or what you’ve spent for a co-working space. Conferences and travel expenses to visit your clients? Definitely. A lot of expenditures may be considered work-related and each country has its own rules on what is acceptable to deduct.

General logic is simple: know your limits and don't try to deduct each diner with your wife. Can you buy a car? Yes, you can, but it shouldn't be a convertible or a roadster. In case you buy a regular car it should be fine, with a few exceptions. When you don’t have an office and you work from home, plus you haven't made any business trips to nearby cities, tax office may not accept your car as an expense. You should understand that there’s a fine line between acceptable and unacceptable.

Also, once you buy something you should keep it on your account as "active". Why? Because your new laptop has some value which will depreciate in time. Every country has a different limit for items that may depreciate after selling. In some places it is up to €100, in others it’s up to €1'000. Usually, you should keep it on your account for a few years, which is also country specific - on average between 3 to 5 years. How do you depreciate your stuff? This is also country specific. In some places, you deduct by a calendar year, in others by a month. Generally, the rules are simple and easy to follow.

So, you should track:

  • Earnings;
  • Expenses (tagged and categorised);
  • Expensive work-related items that depreciate in value each month or year.

Let’s say, each month you earn an income, I. You’ve spent some of it on coffees and other small expenditures, of which you could deduct the whole value as E. Also, you have some expensive items on your account that you’re tracking. For example, a laptop for €1'800 that you can depreciate to zero in value in 3 year — each month it will lose in value €1'800/36 = €50.

So, the profit this month is: P = I - E - €50.

Can it be negative? Yes it can. Can an annual profit be negative? Yes it can. Will your tax office pay you back any taxes from a negative profit? No, but if you prepaid taxes for an expected profit that was over your actual profit, the tax office will return an overpaid amount. And you can move negative profit to next year with some country specified rules.

As you can see, it’s not rocket science if you follow the guidelines. We will help you with it. Just track all your earnings and outgoings, upload invoices and we’ll take care of the value, depreciation, calculate profit and taxes, which should be paid or refunded.

When you sell your services as a sole-trader, the money is yours, everything you buy belongs to you, and in theory it should be pretty simple — but in real life, it isn't. To start with, you're using your bank account not just for work-related spending but also for your personal outgoings. You should keep all your records in good order throughout the year because otherwise, it is close to impossible to track and categorise these entries. How many transactions are on your card? Several each day, which makes it a thousand each year.

As a simple solution, you can split your personal money and work-related money by using separate cards or separate bank accounts. This is another reason we offer you our bank card. Just use it for everything work related. Use it to be paid by your clients. We will track every transaction for you, and all what is left for you to do is upload an invoice or a bill to each transaction, together with a small note.

Moving on, this won’t help you determine your tax residence — this was explained in the logic behind personal income tax. Also, this won’t help you determine in which country and how much you should pay when you move from one country to another, during one financial year.

So, selling the services under your name is looking like a simpler option. That is, if you live in one country, don't move from one country to another during one year, and haven't worked in other countries where you aren’t a tax resident — then it should be simple. Also, don’t forget to use a separate bank account for work. Otherwise, this will turn into a nightmare.

What are the alternatives? Use a one-man-business. A company is a completely different legal entity.  A company will need a bank account. It may own your laptop. Together with your coffee cups.

And when you're selling your services under the company name the line between your personal money and work-related money or things is very bold. Who owns it? You or company? If this is is work-related things — the company owns it.

With this arrangement, it’s best to keep your personal taxes as simple as possible. You might pay yourself:

  • A salary each month.
  • Dividends once a year.

Company taxes aren’t complicated because your spending won't mix with any random transactions, like getting a glass of wine at your local bar. In case you work as an IT freelancer and have a few clients that wire all payments to your account, you won’t have any cash which also keeps your accounting simple.

Which set up brings you more benefits? Usually, the company-based setup has a lower effective tax rate, with a few exceptions in EU - Germany and Denmark, as an example. It’s also best forliability control. In case your company has debt, you account for the company's liability to the limit of unpaid share capital. Yes, the company will account for all that goes wrong, but the company’s value only equates to what the company owns, plus the funds on its bank account. You won’t have a court decision made personally against you, ordering you to pay a few hundredthousand dollars because your company is fined for NDA violations.

What do I prefer? A company based setup. It’s very straight-forward and has better liability control. This is only a suggestion and, of course, the decision is yours.