It seems there are more and more people becoming self employed these days – or at the very least, many folks are starting a side business, turning a hobby into some extra income or doing some type of independent contractor work.
In my day job, I am actually an independent contractor so I know quite well there are some things to remember if you’re self employed.
Whether you’ve decided to turn your blog into a business, sell a multi-level marketing product or rent a storefront to start selling your homemade jewelry there are some mistakes you will definitely want to avoid.
1. Not Setting Aside Money for Taxes
This seems simple enough, but is probably one of the biggest tax mistakes people make among others. The number of people I talk to that haven’t set aside money for taxes is pretty high. If you are a 1099 contractor, the company you are contracted with does not pull out taxes for you.
At first, this feels great because your paycheck is higher – then reality sets in when it’s time to file your taxes.
Uncle Sam requires you to make quarterly estimated tax payments. If you don’t have enough paid in for your estimated taxes you could face some penalties. I recently talked to someone who didn’t think they really needed to set money aside for his independent contractor work and figured he could just use his savings to pay the taxes.
He ended up making a little more than he thought by the end of the year and couldn’t pay all the tax liability. He got whacked with some stiff penalties and is now making recurring payments to the IRS until his debt is wiped out.
Another thing people fail to realize is the self-employment tax that’s due. This was a stiff kick in the gut to me after my first year of self-employment.
Uncle Sam charges 15.3% tax for self-employed in addition to your regular income tax! This is equivalent to the FICA tax on a regular paycheck. The good news is that you can deduct half of your self-employment tax, but you still have to pay!
What I do to help me throughout the year is any time I get paid, I set aside 20% of my money right away into a separate bank account, which is labeled Uncle Sam’s. Then each quarter I take that money and make a quarterly estimated tax payment.
In the fourth quarter I do a quick assessment of where I am in terms of income and tax payments and adjust accordingly. This has worked well for me the last few years.
2. Not Taking a Look at Incorporating
Many self-employed folks start out as a sole proprietor. They themselves are the business and everything (income, expenses and liabilities) gets funneled through their own personal account.
Not everyone should incorporate. If you’re not planning on going “big time” with your business or you’ve decided you just want your hobby to make enough to cover expenses, it probably doesn’t make sense to pay the fees associated with incorporating.
It does make sense, however, to at least consider whether incorporating is right for you. One benefit of incorporating is that you can get around the self-employment tax.
The biggest benefit however is limited liability. This means that the business, not the owner is personally responsible for its obligations. In other words, if the business gets sued, only the business assets are at risk, not all of your own personal assets like in a sole proprietorship.
3. Not Keeping Track of Income and Expenses
This is one of those mundane tasks that most owners hate, but every business must do in order to maximize deductions as well as protect themselves from an IRS audit.
A business owner should really be organized when it comes to tracking daily expenses and income. Don’t write down your mileage on a napkin each time you travel. Your bookkeeper will thank you for that. Or, if you are acting as bookkeeper you’ll appreciate your organization as your business grows.
Get a notebook, use a spreadsheet or some budgeting or personal finance software to track the amount of your expenses, the category (i.e. office supplies) and a brief explanation of what you purchased etc.
Don’t rely on your memory to come through for you when you need to report an expense. Keep your receipts, develop a system and keep up to date.
This may be a bit much depending on what type of business you are in, so just be sure you come up with a system that works for you.
Avoiding these mistakes as a self-employed person will help free up time, save you money and protect your business so you can maintain a long and profitable career.