Planning for your tax obligations as a new entrepreneur

Are you new to being in business for yourself or are you working for the first time as an independent contractor?

You might be eager and excited to head out on your own venture but has your planning covered your tax obligations? As a new independent contractor, sole proprietor, or single member of an LLC (however you are set up), one thing to keep in mind is that you are responsible to pay self-employment tax. All of it. Your clients will not withhold taxes as your employer did. Your clients also want you to understand your responsibility up front, so somewhere in your Independent Contractor Agreement you may have seen verbiage like, “Contractor shall pay all taxes incurred while performing services under this Agreement—including all applicable income taxes and, if Contractor is not a corporation, self-employment (Social Security) taxes.” In order to award you contracts, some clients may even ask for proof that you have paid taxes.

As a newly self-employed individual, talk with your accountant or visit the IRS website to understand tax obligations and how to pay estimated taxes. If you’re paid $600 or more by an individual client, you will receive a 1099 at the end of the year. A copy is also sent to the IRS. However, don’t wait until the end of the year to pay taxes. Paying estimated taxes throughout the course of the year guards you from being hit with a huge tax payment at one time, plus penalties, when you file your annual tax returns. Further, the IRS prefers to be paid as you receive income. If you don’t pay estimated taxes and money is not set aside for taxes, then it will be a huge burden to come up with the entire payment all at once. Or, you will have to go on a payment plan until the amount is fully paid, which can be a burden as well considering you’ll still need to pay taxes for the current year while paying a tax bill for the previous year. Below are three tips that you should find helpful to manage your tax payments:

1. Keep business-related paperwork. Record your income and expenses. Bill your clients in a timely manner and log the payments as you receive them. Be diligent about keeping your receipts for business-related expenses. There are savvy online tools that can help you organize your receipts, or you can go the old-fashioned route and keep a file or envelope on your desk to hold your receipts. To save time in the future, file your receipts immediately as you return to your office. A file in your car can be helpful, too, if you drive a lot for your business and track mileage. You can also track your expenses in a spreadsheet and scan the receipts to the same folder on your computer.
2. Save your taxes. Consider opening a savings account in addition to your business checking account. As you get paid whether monthly, bi-weekly, or per project, calculate the taxes (25% to 30% of your income is usually recommended) and move that amount to the business savings account. When you’re ready to pay the quarterly estimated taxes, transfer the funds back to your checking account to cover the payment. Many banks offer free, unlimited funds transfer between business savings and checking accounts.
3. Pay estimated taxes on time. Set calendar reminders for the due dates (see table below). If you pay by check, make sure to get it in the mail a few days before the due date for it to get to the IRS on time. If you are late, the IRS can charge you a penalty. If you are not employed elsewhere and the majority of your taxes are not being withheld anywhere else for you, then you should be paying estimated taxes, which is scheduled to cover four payment periods:

According to the IRS, generally, 92.35% of your net earnings from self-employment is subjected to self-employment tax. Your accountant will be able to provide you with more information on employment tax rates or you may see more detail on the IRS website.

As a new entrepreneur, there are many things to learn and do and it’s not easy to run the business while doing the client work yourself. However, it’s doable with the right planning. So, take a minute now to set a reminder for the April 15^th deadline.

Disclaimer: This article is for informational purpose only and not meant for legal or tax advice. Consult your accountant or an attorney for professional advice.

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