In the gig economy, being an independent contractor can lead to plenty of lucrative opportunities if you’re good at managing your time and money. For contractors, the situation can quickly become chaotic when you’re juggling multiple income sources, clients, and invoices.
When it comes to handling finances specifically, learning how taxes are calculated for independent contractors is the first step, but our article will focus on money management.
- Save Your Money
When starting out, self-employment income can be described as a “feast or famine.” When business is booming, you’ll have a lot to work with, but when it slows to a crawl, you may only have your savings to live off of. Since you have no guaranteed paycheck, do the following:
- Calculate your average monthly expenses. When your surplus exceeds your expenses, put it away. Ideally, you’ll have enough saved up to live for 6-months.
- Alternatively, you could save a percentage of every paycheck. You’ll still need to save for taxes, loans, retirement, health care, or other purchases, so it’s good to be prepared.
Eventually, you’ll be able to predict down seasons. For example, freelance copywriters often face a slow season after the holidays because businesses will stop promoting their products.
- Manage Cash Flow by Budgeting
Whether you’re going into business by yourself or you have employees, it’s worth it to set up a separate business account. This will make it easier for you to plan your financial needs and prepare for tax time when it inevitably rolls around. Use software to make your life easier.
To make budgeting easier as an independent contractor, follow these tips:
- Request deposits upfront for long-term projects, so your debts and payments are settled. Plus, if the client stops all contact, you still have the money in hand.
- Creating a diverse network is better than getting a full-time gig when you start. When you start freelancing, you need to create a diverse portfolio. It’s advisable never to let one client take up more than 30% of your time unless you trust them.
Hire an accountant if you aren’t good at numbers or need someone to hold you accountable.
- Pay Your Taxes
Independent contractors don’t have taxes withheld from their paychecks. It’s your responsibility to pay your taxes all year. As long as you earn over $400 in a year from self-employment income, you must file a return. Don’t make the mistake of not setting aside tax money.
Most independent contractors will stash away 25-30% of their income all year round. Although that sounds high, it provides enough of a cushion that you won’t be audited or miss payments.
You can also figure out your estimated taxes, which would account for 15.3% of net income. If you make $200,000 or more, an additional 0.9% is added to your Medicare tax (which accounts for 2.9% of the 15.3%. The other 12.4% goes towards Social Security tax).
Independent contractors are expected to pay their taxes 4 times a year on the 15th of April, June, September, and January. If you miss a payment, you’ll be hit with a late fee.
- Take Advantage of Deductions
Businesses can deduct the portion of an expense they use for their business. For example, you can deduct mileage on your personal car as long as it was actually used for your company.
Some of the most common self-employment deductions include:
- Home and Office Deductions
- Retirement Savings
- Health Insurance Premiums
- Employee Pay
- Self-Employment Tax
- Utilities (Internet and Phone)
- Travel Expenses (Entertainment and Meals)
Never forget to take advantage of your deductions, as you can save significantly on your taxes.
- Prepare for Retirement
A retirement account is an affordable investment even without a matching contribution from your employer. Both self-employed retirement plans, the solo 401k and the SEP-IRA are tax-deductible. Deciding which plan is best for you largely depends on your needs.
The SEP-IRA is similar to a traditional IRA. You can open a SEP-IRA with any amount of self-employment income. The solo 401k is only available to sole proprietors who don’t have employees. You can contribute twice to a solo 401k, once as an employer and as an employee.
The more you plan and save, the easier difficult portions of your finances, like budgeting and taxes, will become. Once your finances are sorted, you can concentrate on scaling.