I’ve been self-employed for over three years now, and while it comes with its perks, it can be stressful having a fluctuating income, managing expenses, and making sure that I handle my business finances effectively. Tax time can be especially trying for self-employed entrepreneurs, especially new ones who may not be familiar with specific tax laws. However, the more educated you become about your taxes, the better you can run your business.
Below are four tax tips that every self-employed entrepreneur should know.
Keep Those Accounts Separate
Most entrepreneurs know in theory they should separate their personal checking accounts and their business checking accounts, but sometimes it can be tricky in practice. Even something as simple as forgetting your business credit card when buying office supplies and using your personal credit card instead can throw off your organization and your balances.
John McCarthy, president of McCarthy Tax Preparation, says separate accounts are also crucial for helping your CPA during tax time. He said, “My biggest tip for entrepreneurs is to keep a separate checking and credit card account to make year-end tax preparation easier. If all your income and expenses are separated from your personal finances, both you and your CPA will have a much easier time in April when you are looking for those last few deductions.”
Don’t forget that you often pay your accountant based on the time it takes him or her to complete your returns. So, the more disorganized and complicated your accounts are, the longer it will take them to sort through everything.
Don’t Forget About Quarterly Taxes
Generally, self-employed entrepreneurs have to file an annual return and pay estimated quarterly taxes, which means that you should be paying taxes all year round. If you don’t, you could be facing a huge tax bill. In fact, it’s the tip accountant Mark Tew recommends the most. He says, “Don’t put your accountant or CPA in that awkward position of telling you that you owe $20,000-plus in penalties. Pay your quarterly estimated taxes!”
To make things easier, I consult with my accountant at the end of every quarter. We go over the amount I have to send in and make sure everything is on track. Although it definitely hurts to send in big chunks of money to the IRS four times a year, it does help keep things organized and prevents large surprise tax bills in April.
Know What’s an Expense and What Isn’t
I sure love business expenses, and I regularly ask my accountant what I’m allowed to deduct. Just recently I asked him if I could deduct clothing purchases if they were used towards a blog campaign (he said no!).
I know I’m not the only one who does this. In fact, my accountant Eric Nisall said it’s very important for entrepreneurs to know that “certain items aren’t ‘business expenses,’” such as owner draws, self-employed health insurance premiums, and 50% of meals, yet people incorrectly calculate their net incomes with those figures taken out and end up grossly underpaying their estimates.”
If you have a question about a business expense or how much you’re allowed to claim, whether it’s your home office or your favorite drink at Starbucks while you work, be sure to ask your accountant ahead of time so you don’t get a surprise when it comes to your tax bill.
Take Advantage of Retirement Accounts
Although entrepreneurs grumble about self-employment taxes, there is one huge benefit they have above the traditional work force: some nice retirement account perks.
According to accountant John McCarthy, “One of the biggest benefits for entrepreneurs is the availability of Solo 401k’s and SEP IRAs to save for retirement. Some taxpayers can sock away as much as $53,000 into their retirement accounts and help to reduce their federal tax liability.” He also advises entrepreneurs to consider setting up a savings account early in the year and setting aside a small amount of earnings from revenue as they earn it.
Organization and Preparation
Ultimately, when it comes to tax time for those who are self-employed, it really comes down to organization and preparation. If you spend all your business income without setting aside money for taxes, tax time will be very stressful for you. If you don’t double check your business expenses, especially unusual ones, with your accountant, you could owe more than you originally thought. And, if you mix your personal and business accounts, it can be hard to know how much your business makes every year and what you spend to keep it running.
Don’t forget that monitoring your personal accounts is just as important as keeping tabs on your business. You can use Personal Capital’s free tools to track you whole financial life in one secure place.
The best way to stay organized is to start early and be conservative with your quarterly estimates. If you save all year long and pay taxes every quarter, you will not only have a more intimate knowledge of your business finances, but you’ll also be on track to save, invest, and grow your business year after year.
For more tips on taxes and how to approach your taxes from a holistic point of view, download our free Personal Capital Tax Guide for Holistic Financial Planning.
This blog is for informational purposes only; we are not in the business of providing tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.