Self-Employed: Financial Considerations
Being self-employed can be a rewarding way to make a living. You’re your own boss. You create your own schedule and work environment, choose the people you work with, and get the satisfaction of starting something from scratch.
Working for yourself and building a successful business takes persistence, dedication and resourcefulness. You also must consider important financial aspects. Learn more about the fiscal realities of an independent professional life.
What does “self-employed” mean?
A self-employed person doesn’t work for a specific employer who pays them a consistent salary or wage. They earn income by contracting with a trade or business directly. The Internal Revenue Service (IRS) defines the types of self-employment as:
- Carrying a business or trade as an independent contractor or sole proprietor.
- Being a member of a partnership that carries on a business or trade.
- Being in business for yourself, even part time.
With the freedom of being the one in charge come the responsibilities and challenges. Be sure to prepare both mentally and practically for how to work for yourself.
Start building an emergency fund now
When you run your own business, you won’t always have the same amount of cash coming in each month. To protect against the dry spells, create an emergency fund that provides a safety net for when something goes wrong.
Most experts recommend an emergency fund large enough to pay three to six months of expenses. However, yours might need to be a little larger to provide enough cash to continue running your business, too. Ideally, it should be in place before you go out on your own. Start by deciding how much money to set aside in case you make no income one month. Once you have that number, you can begin to look for ways to save.
Hire a financial and tax consultant
As the boss, you’re responsible for all financial, legal and governmental business requirements. These include sending invoices to clients, documenting all financial transactions, filing tax documents and maintaining licensing requirements. When you’re self-employed, you pay combined employee and employer Social Security taxes, as well as the Medicare tax on your entire net earnings. In addition, you’re required to pay estimated taxes quarterly along with filing an annual return. Hiring an accountant to perform some or all of these functions can help you focus on generating revenue rather than the paperwork.
Referrals are another area where an accountant might help. Those who specialize in small or medium-sized businesses interact with a wide range of business owners. The breadth of clients functions as an information contact network, and an accountant may make referrals between clients that lead to increased sales and business resources.
Keep your personal and business finances separate
If you’re getting into business for yourself, establish separate personal and business bank accounts. Beyond making it easier to manage your money, it’s a necessary step for developing your business credit. It also helps you obtain small-business loans and other types of financing when you need it, as well as better terms from suppliers and vendors.
Follow these steps from the Small Business Administration to establish business credit for the first time:
- Structure your business as a separate legal entity.
- Obtain an employer identification number (EIN), also known as a tax identification number.
- Establish a business-specific address and phone number. If you operate from home, maybe rent a virtual office.
- Apply for a business credit card.
- Use your line of credit consistently and responsibly. Always pay promptly. This way, you build trust and credibility with customers and suppliers, and gradually increase your credit limit.
Set a budget, and track everything
With self-employment, your weekly and monthly income will rise and fall. Establish and follow a budget from the beginning, or you risk running out of money. Track and categorize every single penny that comes in and goes out. Without accurate financial records, it can be almost impossible to see where your business is headed.
A bookkeeper can be invaluable. They’re trained to catch small mistakes that can lead to big consequences. Likewise, they’re familiar with the ins and outs of your business income and expenditures, making it a snap to manage invoices, pay for supplies and reconcile everything neatly for tax time.
If you prefer to do the bookkeeping yourself, set aside a day each month to sit down with your credit card and bank statements and check everything. There are loads of online tools you can use to track income and expenses, generate profit-and-loss statements and balance sheets, print invoices, track payments and receivables, and manage inventory. Try a few and figure out which feels the most intuitive to you.
Protect yourself and the business
You may lose your company-provided life insurance if you leave your current position and venture out on your own. If other people depend on you financially, whether family or a business partner, it’s vital to have life insurance coverage in place for the unexpected.
When you’re self-employed, insurance specifically designed to protect your equipment and professional liabilities is essential. Generally, if you make money doing something, your activities are considered a business − even if you run it from home. You can’t rely on your standard homeowners/condo/renters policy because it may exclude business-related items or events, or provide limited coverage.
While your needs will vary based on the nature of your work, most business owners invest in property, liability, commercial auto and workers compensation coverage. Consult a qualified insurance expert to make sure you get all of the protection you need.
It may seem obvious, but be sure to pay yourself. It’s OK if you can’t do that regularly and easily at first. Nevertheless, you should have a timeline for being profitable. Pay yourself from your business account to your personal account. Your accountant will ensure the money is classified as “salary” for tax purposes.
While you’re at it, remember that your retirement account is entirely in your hands when you’re self-employed. You might set up an IRA, or put money into a high-interest savings or checking account or mutual funds. The important thing is to be consistent about saving for retirement.
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