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As an independent contractor, the law classifies you as a business. As a business, you will need to pay taxes and keep up with your bookkeeping as well. You likely became an independent contractor to get away from the typical workday or have a particular skill that businesses desire. However, you may not have realized how important it is to make sure you keep up on bookkeeping and accounting as an independent contractor.
People who work routine 8-5 jobs for a company are classified as an employee. The business they work for will withhold and report a portion of the employee’s wages. A percentage of each check is withheld to fund unemployment, social security, Medicare, and tax liability. Each year, all employee taxable income is proven on a W-2 form and filed to the IRS.
This goes for all employees of a company. However, when a company hires an independent contractor, it is different. Contractors are held reliable for their tax payments and do not rely on businesses to withhold income tax for them.
This might all sound intimidating, but with the right help, you will be handling your taxes and bookkeeping like you know what you are doing!
Essentially, as an independent contractor, you are not an employee of the business you are working for. An employee will receive wages regularly, have taxes withheld from those wages, have their schedules created by their employer.
An independent contractor is the opposite of an employee. You will get paid for the projects you work on, do taxes on your own, and work when you want to work.
As an independent contractor, you have a lot more freedom than employees of most workplaces. You pay taxes on your own, set hours on your own, and you are your own boss.
The trade-off is that your employers do not put money towards your health insurance, workers’ compensation, bonuses, unemployment taxes, payroll taxes, or contribute to your 401(K). You will also forgo employee benefits like the Occupational Safety & Health Act (OSHA), the Fair Labor Standards Act (FLSA), and Title VII of the Civil Rights Act.
There are two main accounting methods that independent contractors can choose from when filing their first tax returns as a business.
It is best practice to reach out to a CPA for advice when choosing what accounting method will work best for your independent contracting business.
Independent contractors need to pay the IRS self-employment taxes. Currently, that means you will pay social security 15.3%-12.4% and Medicare 2.9%. You will pay through filing a Schedule SE.
A Schedule SE will be one of the schedules of your individual income tax return Form 1040. Before filling out your SE, you will calculate the total of your self-employment income/loss with the Schedule C form of Form 1040 on line 31.
Anytime you complete more than $600 of work for a client, they will need to file and send you a copy of Form 1099-MISC. This is an information form for filing to send non-salary income numbers to the IRS. If they do not send you a Form 1099-MISC, you will want to follow up with your client.
It is important to note that independent contractors have to save money to pay their own contributions to self-employment taxes, Medicare, and social security.
Keeping on top of the accounting and bookkeeping practices of your business is crucial to all independent contractors.
Proper bookkeeping will help you set up financial reports that let your plan and make educated decisions for the future.
Having organized books will also help your business ensure that every invoice is sent out on time, that your accounts receivable is not going unpaid, and that you pay your credit card bills.
Tracking the money you bring in and the money you send out of your account is essential as an independent contractor.
Recording every expense is necessary whether you are big or small. If you do not have the documentation, you cannot back up your costs if there is an audit.
There are many ways an independent contractor can track their income and expenses. How your friend does their bookkeeping might be different from how you do it. Most importantly, you must find a financial tracking system that works for you and stick to it.
Examples of what to track:
You will want to open a bank account specifically as an independent contractor business. This will help you separate your financial status from your businesses. In the case of an audit, it is helpful to have everything separate, primarily if you classify yourself as a business. Different accounts will help you prove your records if your claims are in question.
If you are a contractor for hire, you can still get paid. However, it is highly beneficial to create your Employer ID Number. There are many tax benefits and saving that come along with having a business entity.
If you do not file your profit and expenses, you are putting yourself at risk of being audited by the IRS. The wages of a contractor are questioned during audits.
Paying taxes and having accurate snapshots of what you are estimated to pay in taxes helps a lot. Paying in your estimated taxes every month or quarter will help you avoid unexpected tax liability.
As a general rule, independent contractors should save anywhere from 30-40 percent of their income for tax purposes.
No matter how successful you feel as an independent contractor right now, it would help if you looked to the future. The future can change quickly in today’s marketplace.
This month can be a lot different than the same month last year. Financial reports can prepare your business for the future by looking at your past and present to prepare you for future decisions.
Saving money and paying estimated taxes in advance will help set you up for a more promising future.
Let’s face it unless you are a bookkeeper or accountant working as an independent contractor, and these skills are likely not your strong suit.
Accounting software can help even the most accounting inept people to become capable organizers of their books!
The most considerable benefits of accounting software for contractors are helping you get paid, giving you data for accurate financial records, help you with your tax estimates, and so that you are not overwhelmed if an audit comes your way.
Getting paid for your work is vital for any contractor. Accounting software will make it easier to do so with the ease of invoicing. Accounting software allows you to invoice your clients and keep up on unpaid invoices.
Above all else, the most significant benefit of utilizing accounting software is creating accuracy and order within your business. Many new small business owners will start by entering all of their bookkeeping on an Excel spreadsheet. The manual labor of entering data into Excel is likely to bring mistakes. The software will automatically take your invoices, payments received, payments returned, and expenses to organize your books.
If you are not diligent in separating your personal and business bank accounts, you might get paid directly to your personal account.
Getting paid to your personal account can be too tempting to sweep it under the rug. While there are short-term benefits, like not paying taxes on that money, it is not worth being caught during an audit.
As a contractor, keeping your accounting transparent will also allow you to see your income and expenses more clearly. The clarity in financials will allow you to make smart decisions on the growth of your company.
Independent contractors need to be thinking of bank account reconciliation. The practice of reconciliation will help you ensure that every transaction matches your accounts. It is also a great way to prepare yourself for tax season.
If you attempt to reconcile your books on your own, it can be a monumental task. Using accounting software like Zero, Wave, or Freshbooks, will allow you to reconcile your bank accounts quickly.
Many new independent contractors will start out doing bookkeeping themselves. Cash can be tight early on, so being responsible for your books can help you save some money while starting your business.
As your business continues to grow, you will see how beneficial it would be to have the time you spend on bookkeeping to complete work within your expertise, acquire new clients and more. Hiring a professional to take care of your bookkeeping services will allow you the freedom you need to grow your business as an independent contractor.
For most independent contractors, it will be beneficial to bring in a CPA to at least help during tax season. A good accountant can help you with tax season and also create and decipher financial reports like your balance sheet, income statement, statement of cash flow, and more. It gives you a more transparent look into where your business is right now and how it is trending.
When deciding to bring in a professional or not, you may ask yourself if you can afford to. However, what you should be asking is, can you afford to not bring in a professional to help with such important information.
Independent contractors may sometimes seem like another employee, but they are a completely different business entity than the businesses they perform work for.
An independent contractor does not have the ease of having an employer take their taxes out of each paycheck. Instead, independent contractors are their small businesses. They need to focus on their books and their accounting.
Having a clear picture of their financial figures will help any independent contractor understand their business better. They will be able to pay their taxes to the IRS with more accuracy. They will better understand how to charge for their services by understanding their expenses.