Handling Your Finances as an Independent Contractor or Small Business Owner

Going from a salaried employee to an independent contractor or small business owner is a huge transition. It’s a significant change emotionally and financially. Getting a handle on your finances will ensure your success and the sustainability of your professional path.

Whether you’re just getting started or you need to fine-tune your financial planning, here are a few strategies on handling your finances as an independent contractor.

1. Choose the best structure for your business.

If you’re just getting started or doing part-time work, being a sole proprietor makes the most sense. You’ll pay yourself in the form of a draw or distribution. As a limited liability company (LLC), you can pay yourself a salary plus you can receive a draw, dividend or distribution. You’ll also benefit from liability protection as an LLC.

Billing as a company with your business name and employer identification number will be especially reassuring for clients that are just starting to work with you.

2. Seek professional advice.

If you’re unsure of what kind of business structure makes the most sense, reach out to an attorney for advice. You’ll want to consult one for drafting contracts for clients.

Reaching out to a coach or mentor as you develop your business plan is another way to ensure your business model is sound. They could also be a resource to turn to when you are seeking advice. You’ll want to have trusted contacts when navigating unfamiliar financial territory.

3. Spend time developing your budget.

Adequately determining the cost of your services is an essential step to the financial health of your business. You want to keep in mind industry standards, the type of clients you’re working with, as well as the value of your experience level. Make sure to factor in overhead costs into your pricing.

An accountant can help you set up a solid, record-keeping practice. If you can’t afford one, invest in a well-respected accounting or budgeting software. Researching software can save time, such as an invoicing app if you regularly invoice clients.

If you’re just starting out, create two budgets:

• One for a best-case scenario, with a high income.
• Another factoring in a lower income.

Having a conservative budget prepared can help navigate earning less revenue than expected.

Review your budget each month, comparing actual costs with anticipated costs. Tracking this over time will help you to adjust your budget.

4. Set aside money to make quarterly tax payments.

Since you don’t have an employer withholding Social Security or Medicare, you are required to submit estimated tax payments each quarter. This is known as self-employment tax.

Quarterly payments will help you manage your cash flow so you don’t have any big surprises (or late fees) at the end of the year. We recommend setting up a separate savings account to plan for this expense.

The IRS form 1040-ES can help you figure and pay your estimated tax. Make sure to use the form for the current year as it is updated each year. Refer to the IRS website for complete guidelines on tax obligations for self-employed individuals.

5. Get organized to manage tax deductions.

First, you’ll want to set up separate business and personal accounts to make a clear distinction between your professional and personal expenses. You can deduct business expenses that are normally used or required for the type of work you do.

If you want to deduct travel expenses, use a mileage tracker. For home office expenses, you can use the IRS simplified, home-office deduction guidelines.

6. Protect yourself for the unexpected.

By having a diversity of projects, clients, and revenue streams, you’ll be better able to handle a financial hit when one of those disappears or gets disrupted. Work toward setting aside 20 percent of your income or try to have six months’ worth of living expenses saved. You’ll be prepared to face a change in revenue or an economic downturn that is out of your control.

7. Prioritize debt reduction.

If you’ve taken out a loan to get your business started, make sure to allocate payments in your budget right away. Ensure you have a steady flow of work so that you can pay off any debts. Eliminate any non-essentials from your budget to make this happen faster.

8. Plan for retirement and healthcare expenses.

Being an independent contractor or small business owner means you need to manage your retirement and healthcare plans. No matter your age, you need to set aside and prioritize money for both.

For your retirement plan, you can choose between a 401K or a simplified employee pension IRA. With the 401K, you can contribute to a traditional IRA fund with pre-tax money or to a Roth IRA with post-tax money. Consult a financial advisor for the type of funds that correspond with your projected income and stage in life.

You can enroll in a healthcare plan through the Individual Health Insurance Marketplace. Refer to HealthCare.gov for information on coverage options and questions. If you don’t have health insurance, you’ll need to check with your state to see if there is a penalty fee.

We recommend enrolling in a plan that suits your personal and financial health so that you can take care of yourself, keep your business running, and plan for the unexpected injury or health coverage needs.

Independent contractors and small business owners enjoy many benefits that come along with their autonomy, but it requires a sharp eye on finances. Make sure to create the business structure best aligned for your work. Develop a strong understanding of tax deductions and payments. Also, budget for expected and unexpected expenses.

Seek support and share resources with your network of small business owners. With these strategies in mind as you develop and expand your business, you’ll be able to manage your finances effectively as an independent contractor or small business owner.