There’s nothing more appealing than being your own boss. You get to set your own hours, decide which tasks you want to take on, work in environments that suit you and earn money that isn’t capped by a standard salary. These are just some of the reasons that self-employment is on the rise with 15 million US workers choosing the path up from 14.6M in 2014..
Of course, self-employment also has its pitfalls. One of the biggest adjustments is learning to manage your finances. Whether you’re new to self-employment or you’ve been your own boss for years, beware of the following money mistakes that self-employed professionals most commonly make.
1) Forgetting To Account For Taxes
Forgetting to account for taxes is single handedly the largest mistake newly self-employed individuals make. Not having an employer to withhold taxes from every paycheck is double edged sword: One the one hand, it’s nice to be able to have your tax money earning interest in a savings account before it’s forked over to the IRS, but, on the other hand, you have to remember to save enough to actually be able to pay all of your taxes.
It’s difficult to know how much you’ll owe in taxes when your income varies year to year and month to month. The best way to budget for taxes is to set aside 25-30% of each paycheck that you receive. The nice thing about not having any money withheld is that you can spend more in months where money is tight. However, if you do use more of your cash in one month, it’s important to keep in line with the 25-30% goal by saving more in the next month.
2) Shying Away From Incorporation
Incorporation does not make sense for every self-employed individual. If you aren’t planning on growing your business, then incorporation likely isn’t the best option for you. Nevertheless, if you can pay the fees associated with incorporating you’ll avoid having to pay the 15.3% self-employment tax rate, which will allow you to avoid overpaying on taxes.
While not entirely money-related, the limited-liability that comes with an S-Corp can be beneficial as well. If your business is organized as an S-Corp you are not considered personally responsible for its obligations. In other words, only your business assets are at risk if your business is sued.
3) Not Tracking The Numbers
Even if you’re a company of one, you’re running a business and need to account like one. You should be keeping detailed records of all of your expenses, sales, income and assets. Knowing where you stand financially will allow you to make strategic decisions that will keep your venture in self-employment afloat. Most computers come packaged with spreadsheet software, but it’s wise to explore accounting software with greater functionality. WiseStamp recently partnered with QuickBooks to offer a free 30 day trial of QuickBooks Self-Employed so you can track income, monitor expenses, and send invoices all in one place.
4) Failing to Separate Business and Personal Finances
It’s easy for work and life to intermingle when you’re self-employed because work may not be something you can just leave behind at the office. Nevertheless, when it comes to finances your work and personal finances need to be separated. This means you’ll need separate bank accounts and credit cards for your business. It also means you’ll have to pay separately for business items.
As previously mentioned, you need to treat yourself like a business and account for all of your income and expenses. It can be difficult to do so when your business activities are jumbled in with the rest of your finances. Not to mention, the IRS expects you to separate your business and personal expenditures. If you ever find yourself in the middle of an audit, you’ll be paying a handsome sum to get everything organized. Separating accounts will not only keep you more organized, but could also save you money.
Here’s an extra incentive: You can write off your credit card fees, bank service charges and finance charges if they’re fees related to business-only accounts. Better yet, you may be able to capitalize on tax deductions that you otherwise would have missed. More deductions and write-offs ultimately mean more money in your wallet. For more help, here’s a guide on using Quickbooks to track your financials!
5) Spending Without Saving For Emergencies
Financially planning for emergencies or any unforeseen circumstance is essential. If you haven’t done so already, you should create an emergency savings fund to pad your bank account should your business have a bad month or two. How much you save is completely up to you. Some individuals save up to a full year’s worth of expenses and others save for a few months of rent payments. At the very least, you should save enough to cover your expenses for a month. A dedicated emergency fund can be a huge lifesaver, that could very well keep you out of serious financial trouble.
6) Borrowing From Friends & Family
Depending on your business and your long-term goals, you may need to borrow money to expand your operation at some point. While there are various methods to fund your business, friends and family should be a last resort. Borrowing from loved ones often allows for more flexible lending terms and a lot less stress, but it also changes your relationship. Entering into a business transaction with a personal friend or family member means business gets personal.
Should your income fall short you may completely ruin your relationship if you can’t repay the debt you owe. Thus, it’s best to avoid the potential for awkward family gatherings and seek capital from banks, angel investors, venture capitalists and crowdfunding campaigns instead.
7) Thinking In Terms of Dollars Instead of Percentages
Budgeting can be challenging (to say the least) when you’re self-employed. How do you know how much to save and spend when your income is constantly varying? Like planning for your self-employment taxes, the key is to think in terms of percentages instead of dollars. If you focus on saving X or Y dollars each month, you run the risk of putting aside too much during low-income months and too little during months of high-income. Instead, allocate a percentage of each paycheck to various pieces of your budget.
How you allocate your paycheck is completely up to you. An ideal budget looks something like the following:
- 40% Necessary Expenses
- 30% Taxes
- 15% Retirement & Investments
- 15% Leisure & Travel
This breakdown may not make sense for your needs, but it’s a good starting point to formulate your own budget percentages. In the end, nothing will give you more satisfaction and peace of mind than maintaining a healthy, well-balanced budget.
Most of the most common mistakes above can easily be avoided with the right amount of awareness and financial planning. Some of the proactive solutions to avoid financial distress can feel burdensome at the time: Saving for taxes, separating your accounts and saving for emergencies, for example, but, you’ll thank yourself in the long run.
Michael Benson is a certified accountant, investor, and attorney. In 2013, he founded his own bankruptcy firm in St. Louis, where he now assists individuals in repairing and improving their financial situations.