Freelancing Money Matters
July 9, 2008 |
Being self-employed brings a whole new set of financial skills to the table that you need to master. Being a self-employed freelancer heightens the need for good money management because the work can be unsteady and sporadic, so you need to be able to manage your finances over those peaks and valleys.
In this section, well cover a number of topics that address this:
- Managing Your Finances
- Solving the Cash Flow Challenge
- Keeping Track of Expenses
- Tax Implications of Freelancing
- How to Provide Yourself with a Benefit Plan
Managing Your Finances
Depending upon your financial circumstances, it’s generally a good idea to wait until you have at least a 6 - 9 month nest egg built up before you quit your regular job and jump into freelancing. At least plan on having another source of money coming into the household because chances are it will take a period of time to get established and have a steady income. You may even want to consider just freelancing part time at first.
Also, discuss your decision to “go freelance” with your family to make sure you have their support and willingness to help you financially until you break even.
Solving the Cash Flow Challenge
Cash flow, simply put, is answering the question “do I have enough money in my business checking account to cover my expenses?” A “Yes” means you have a positive cash flow. “No” means your cash flow is negative. You can’t have a negative cash flow for very long and still survive in business. By being vigilant about your expenses, you can control your cash flow to the extent that you have money coming in. Use a simple spreadsheet program to track your income and expenses. By projecting these items over time, you can develop a cash flow forecast that will help you prepare for lean times or schedule payments for when you have money coming in.
Until you hit the big time, cash advances on projects are rare. Depending on the nature of your work, and the customs in your industry, you may be well underway in completing the work or indeed have completed the project before you start seeing any money. You may be able to ask for quick turnaround on invoices, but sometimes you are subject to the client’s 30 or 60 day pay cycle. Smart freelancers ask questions up front on what the client’s payment practices are and build terms into their contracts that spell out an agreeable payment schedule. If you establish milestones and deliverables during the project, you can often send out periodic invoices billing clients for work completed.
Keeping Track of Expenses
It’s imperative that you keep track of all expenses associated with your freelancing business. Not only might you be able to bill your clients for those expenses, but you can use them to offset income on your tax return.
Most of us would be surprised at what we spend on a day to day basis. Those trips to the convenience store to pick up a necessity like milk or bread end up costing a lot more because of the “incidentals” like newspapers, batteries, or gum that you also end up buying. On the business side, a trip to the office supply store to buy printer ink suddenly ends up also supplying you with envelopes, paper fasteners, and a new desk lamp that you hadn’t originally planned on. We’re not saying that you shouldn’t buy them if they’re needed. The point is, expenses add up quickly and you need to keep track of them.
There are software programs like Quicken
Tracking expenses creates clarity, and clarity about spending means you can make better choices about where your money goes.
Tax Implications of Freelancing
The tax laws differ in each country, but generally speaking, a freelancer who has not set themselves up as a company or partnership will pay taxes on freelance earnings as ordinary income. This means that they cannot claim deductions for any business expenses that they may incur and may end up paying taxes at a higher rate.
A way to avoid this is to be aware of your options. Your form of organization is the first step. By setting yourself up as a company, partnership or corporation, you change your income status from earning money as an individual to earning money as a legal entity, which entitles you to some tax benefits as well as legal protections. While you may incur other kinds of taxes as a company, generally the money you save in the long run is worth it.
In the United States, the limited liability company, or LLC, has become the most popular choice for small business formations since the Internal Revenue Service approved it in 1988. This is because it retains the best liability protection features of a corporation, while protecting a business owner’s personal assets. This protection is not available to sole proprietors. From a tax standpoint, LLCs are taxed like partnerships, so there are no federal corporate taxes and the members, as they are called, just need to file a Schedule C form to claim business expenses.
Among the tax deductions you have as a company that you cannot claim as an individual are:
- advertising your business
- professional fees for attorneys and accountants
- auto expenses directly related to the business
- cost of renting or leasing equipment, vehicles, your office, or other property used in the business
- seminars and other educational expenses related to your profession
- expenses incurred for the business use of your home
- fees paid to subcontractors you may use to supplement your services
- business insurance
- office supplies and postage
- professional association dues
- travel, meals, and entertainment
These are deductions allowed in the U.S. What you are able to claim in other countries will largely be determined by that country’s tax laws.
The general rule for deductibility is that the expense needs to be:
- ordinary and necessary - common, acceptable, helpful, appropriate for your line of business
- directly related to your business - must be incurred by the business itself, otherwise have to proportion the part that is personal
- reasonable and customary - cannot inflate the amount actually spent and need to be similar to what others would have to pay
One of the things that surprise employees turned freelancers in the U.S. is that they now have to pay estimated taxes. Once you start earning income over a certain amount on your freelance earnings, the federal government wants their income and self-employment taxes four times a year. If you live in one of the income tax states, you may owe taxes to your state government officials as well. Even some local governments, like New York City, have income tax on their residents.
U.S. employees receive Form W-2 from their employers reporting their income and indicating amounts withheld for taxes. As a self-employed freelancer, you will no longer receive W-2s, but may receive Form 1099 MISC from clients that pay you more than $600 in fees and who will request a Form W-9 from you to obtain your tax number.
The Flip Side
As a provider of services, you may also be subject to paying sales taxes to a municipal and/or state taxing authority. As such, you will need to register with them in order to be authorized to collect the appropriate taxes. Not all services are taxable, so be sure to research the government requirements that may apply to your profession first.
How to Provide Yourself With a Benefit Plan
One of the big downsides of freelancing and being self-employed in general is the lack of good alternatives for benefits coverage. You may be in a situation where you are covered under a family plan or have spouse coverage, and if that is the case, consider yourself lucky. For the rest of us, health insurance options are available, but are very costly.
There is an advocacy group called Freelancers Union that is working to make health and dental coverage, disability insurance and retirement plans affordable for those who freelance. They are a nonprofit organization that represents the needs of today’s independent workforce though advocacy, information, and service.
By visiting the Freelancers Union web site, you will be given an opportunity to receive a quote on discounted or group rate health, dental, long term disability, and term life insurances. Membership is free and is open to all independent workers — freelancers, consultants, independent contractors, temps, part-timers, contingent employees, and the self-employed. In addition to their advocacy role, Freelancers Union also provides opportunities for members through event sponsorship, an online forum, a gig listing, a blog, and various discounts.
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