Transitioning from getting a regular paycheck to getting paid as a freelancer can result in tax shock if you have failed to properly plan for your tax liability. With some simple planning, it can be much less traumatic.
CAVEAT – The following constitutes general suggestions of the author who has been self-employed for 13 years. It does not constitute legal or tax advice for any particular reader and by no means is a substitute for advice of a tax professional.
Regular paychecks have taxes withheld in an amount that at least approximates your tax liability at year’s end. This, of course, does not happen with self-employment income. Not only are there no withholdings, but you will probably be subject to self-employment tax in addition to your regular tax rate. Failure to pay estimated tax payments (as many freelancers do), you could result in a hefty tax bill on April 15th and possibly even additional penalties.
There are ways to avoid or minimize this unpleasantness.
First, and most importantly, talk to a CPA. It is impossible to overestimate the value of a competent CPA to your business. They can review your personal financial situation and make appropriate recommendations for recordkeeping and tax planning that fit your own situation.
Second, separate your business and personal finances. Whatever the structure of your business, take practical steps that will allow you to record and track income and expenses that are related to your business. It is complicated and inefficient to go through your personal checkbook to pull out business-related expenses for your tax returns, or other purposes. A simple solution can be to have a separate checking account into which you deposit all fees earned, and out of which you pay all business expenses. This will help you work with your CPA to maximize available deductions and ensure that your tax returns are correct.
Third, set aside money for taxes where you won’t be tempted to spend it. Armed with the information from your CPA, allocate a certain percentage of each paycheck to estimated taxes. It can be helpful to set this aside in a separate savings account to have handy for estimated tax payments or year end tax liability. Remember, your employer took this money out of your paycheck before, now you are your own employer.
CAVEAT – The following constitutes general suggestions of the author who has been self-employed for 13 years. It does not constitute legal or tax advice for any particular reader and by no means is a substitute for advice of a tax professional.
Regular paychecks have taxes withheld in an amount that at least approximates your tax liability at year’s end. This, of course, does not happen with self-employment income. Not only are there no withholdings, but you will probably be subject to self-employment tax in addition to your regular tax rate. Failure to pay estimated tax payments (as many freelancers do), you could result in a hefty tax bill on April 15th and possibly even additional penalties.
There are ways to avoid or minimize this unpleasantness.
First, and most importantly, talk to a CPA. It is impossible to overestimate the value of a competent CPA to your business. They can review your personal financial situation and make appropriate recommendations for recordkeeping and tax planning that fit your own situation.
Second, separate your business and personal finances. Whatever the structure of your business, take practical steps that will allow you to record and track income and expenses that are related to your business. It is complicated and inefficient to go through your personal checkbook to pull out business-related expenses for your tax returns, or other purposes. A simple solution can be to have a separate checking account into which you deposit all fees earned, and out of which you pay all business expenses. This will help you work with your CPA to maximize available deductions and ensure that your tax returns are correct.
Third, set aside money for taxes where you won’t be tempted to spend it. Armed with the information from your CPA, allocate a certain percentage of each paycheck to estimated taxes. It can be helpful to set this aside in a separate savings account to have handy for estimated tax payments or year end tax liability. Remember, your employer took this money out of your paycheck before, now you are your own employer.
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