Running a small business or working as an independent contractor can be an exciting and fulfilling way to make a living. Self-employed people also face a whole new set of risks and tax considerations that they have to account for.
Here are 10 tips to help business owners and independent contractors navigate these risks and maximize their profitability:
1. Save for taxes.
When you’re self-employed, you don’t have an employer that withholds taxes from your paycheck every two weeks. As a result, it’s essential to put aside roughly 20% to 35% of your income each month to pay for taxes. (Remember: in addition to income taxes, you’re also responsible for the full 15.3% of Social Security and Medicare taxes.) You will also want to make sure you don’t get hit by the underpayment penalty, so you need to make adequate estimated tax payments each quarter.
Understanding and Avoiding the Underpayment Penalty
2. Save for retirement.
Many business owners don’t take advantage of the most valuable deduction of all: saving for retirement. A recent study from the American College found that about a third of small-business owners do not have a personal or business-sponsored retirement plan in place.
An IRA or one of the plans that is designed for small businesses, such as a Simplified Employee Pension (SEP) IRA, a Savings Incentive Match Plan for Employees (SIMPLE) 401k, or a SIMPLE IRA, allows you to make tax-deductible contributions for your retirement. And unlike other kinds of business deductions, the benefits of retirement contributions go directly into your pocket.
Saving for Retirement is a Small-Business Owner’s Most Valuable Deduction
With retirement savings—regardless of whether you work for a company or are self-employed—time is of the essence. The earlier you start, the more you are able to leverage the power of compounding gains. At the other end of the spectrum, once you start approaching retirement, you may want to consider making catch-up contributions to make sure you have enough for retirement.
3. Maximize your deductions by tracking your expenses.
You can’t claim all of the deductions that are available for business owners and independent contractors if you don’t know what your expenses are. It is extremely important to use QuickBooks or some other bookkeeping system to track your expenses and revenue. Not only will this help you reduce your tax bill and protect yourself in case of an audit, it will also save you money with your accountant. The cleaner and more organized your files are, the easier (and cheaper) it is for your tax advisor to prepare your tax return.
4. Track your auto mileage.
Deductions for the business use of your vehicle can generate significant savings. But this is also one of the areas that will be closely examined in an audit. If you want to take advantage of the auto deduction, you need to track your mileage and collect an odometer reading by getting an oil change on (or near) December 31 each year.
Tracking mileage has always been a nuisance for business owners, but now it’s a lot easier thanks to smartphone apps that automatically track your mileage. I use MileIQ, and I highly recommend it. If you use your car for business, you should commit to using MileIQ or one of the other mileage tracker apps starting in 2015.
Get More Mileage Out of the Automobile Deduction
5. Consider forming a legal entity.
Setting up your business as a limited liability company (LLC) or an S corporation can provide valuable legal protection for business owners and contractors. It can also result in significant tax savings compared to operating as a sole proprietor or partnership. Consult with your tax and legal advisors to determine what type of entity makes the most sense for your business.
6. Know the home office rules.
If you work from home, you might be able to deduct part of your mortgage, insurance, and utilities as a business expense. The rules about home office deductions can be fairly complicated, but thankfully the IRS recently made claiming the deduction a lot simpler by creating a home-office standard deduction.
Introducing the Home Office Standard Deduction
7. Explore your health insurance alternatives.
Having to pay for your own healthcare is one of the biggest expenses that small-business owners and contractors face. The private insurance market for individuals has undergone significant changes in recent years because of the Affordable Care Act. It is important to explore the new insurance exchanges and know all of your options for coverage, including high-deductible policies that are linked to a Health Savings Account (HSA), as well as the available tax deductions for healthcare expenses.
8. Don’t forget about other types of insurance.
Health issues aren’t the only risks that business owners and contractors need to insure against. You should also evaluate your need for disability, liability, and errors and omissions insurance. Also, if you have employees or hire contractors yourself, you will need to look into whether you need to get workers compensation insurance.
9. Understand the difference between 1099 and W-2 workers.
If you hire people to work for your business, you need to know whether these people should be classified as 1099 contractors or W-2 employees. The tax implications of this classification can be fairly significant. While there is no black-and-white rule for making the distinction, generally speaking, the more control you have over the worker, the more likely that the worker is an employee. The IRS provides 10 guidelines to help determine whether a worker is an employee or a contractor.
Employee or Contractor? 10 Ways to Make This Important Distinction
10. Focus on growing the business.
When you’re running your own business, it can be very easy to let delivering for existing clients take over all of your time. Sometimes working in the business prevents people from working on the business. Carve out time to market to new customers and think strategically about identifying ways to grow. You also need to dedicate time to learning how to efficiently manage your finances and bookkeeping. The time, energy, and money that you devote to these activities is an investment in the future of your company.
At Eilts & Associates, we work closely with small-business owners and independent contractors to help them navigate all of the financial opportunities and risks facing their businesses. If you have any questions about any of these 10 tips, please contact us at 773-525-6171 or firstname.lastname@example.org.