Financial Tips for the Self-Employed

Financial Tips for the Self-Employed

After many years in the typical workforce, not all of our clients retiring from their primary jobs are ready to slow down. Some actively transfer their professional skills to consulting and contracting work. This could involve serving on a professional or charitable board, speaking at conferences, or providing consulting services.

Additionally, we see younger clients or children of clients starting their own businesses. The effect of COVID-19 on the economy also has led to many workers quitting their jobs and starting their own gigs.

Whether you’re at the beginning or final chapter of your career, being self-employed requires deeper financial planning for tax and legal issues, as well as your final retirement.

Below are some key financial planning items to consider when you engage in income-producing activities outside of your typical job, such as consulting or freelance work.

Draft a business plan

Even if you’re starting small, a business plan will help you determine the purpose and goals for your new venture. Think about the type of work you’ll be providing. Do you plan to do everything on your own, or will you be hiring others to help you? What assets or services will you need — website, marketing, bookkeeping, legal, car, office, etc. — for your business to be successful?

Establishing your business structure

For tax purposes, there are several ways you can set up your company. Choosing the correct structure will depend on the scope and size of your business.

If you’re the only member in your firm, two common ways to establish your business are as a sole-proprietorship or single-member limited liability company (LLC).

With sole proprietorships, there’s no separate business entity. Therefore, you may be held personally liable for your business obligations. Sole proprietorships are simple to set up and you can register a trade name (DBA – “doing business as”) if you do not want to use your name. Sole proprietorships are appropriate if your business is low-risk or if you’re just starting out.

Another common structure is an LLC. As noted in the fathom post All About the LLCs, there are two types of LLC structures: single-member and multi-member. Expenses and income pass through to your personal tax returns. LLCs provide liability protection so if your company face a lawsuit, your personal assets are protected.

There are many more business structures such as S corporations, limited partnerships, C corporations, etc. Your legal or tax advisor can help you decide on the appropriate structure for your business.

Some clients start their consulting business as a sole proprietorship, then form a single-member LLC, and eventually convert the single-member LLC into a multi-member LLC to bring on business partners to share the management, profits and expenses of the business.

Time to file the paperwork and set up accounts

As a sole proprietor or a single-member LLC, you could conduct business using your Social Security number. But if you plan to hire contractors where you’ll need to file Form 1099s, we highly recommend applying for an Employer Identification Number (EIN) from the IRS. You can apply online at or download and mail in Form SS-4.

If you’re setting up an LLC or a DBA (doing business as), you will need to register with the state that you’re conducting business in. Remember to look up the business name on the state secretary website to see if it’s available. Your approved state registration is required before you can apply for an EIN.

Dealing with the finances

It’s a best practice to have a separate checking account for your business to record income and expenses. A business account also makes it easier to review transactions for your budget and tax filing.

Provide the EIN and the DBA or LLC name to the bank, and they can set up a business bank account for you. This will allow you to have separate checks and debit cards with the business name.

Decide what professional help you’ll need. In particular, you’ll probably want a tax accountant who specializes in small businesses and maybe a lawyer to help you establish your business structure and advise on legal issues. A wealth manager with small business expertise can help make sure your business finances align with your personal financial plan.

Also look for apps and other tools that can help you manage your business. Start with accounting software such as Freshbooks or Quickbooks. There are also apps that can help with tracking expenses and mileage. For example, with Expensify, you can scan your receipts and notate business purposes for the purchases for tax deductions.

Board members are often allowed to be reimbursed for board-related expenses. I asked one of our Exclusive Family Office clients about how he manages expenses, and this is what he said:

“Expenses for me as a board member are simple. I accumulate hard-copy receipts for each board and put them in separate envelopes. Then once a month, to the extent that I have any expenses, I scan them using Adobe scan, create a pdf and send them to an admin at each company to submit.”

By keeping track of the expenses related to the consulting business, you can determine if staying on the board or continuing with the consulting service for a particular company is profitable or not.

Business tax considerations

As an employee, your employer withheld income taxes on your behalf at each pay period. As a self-employed individual, since taxes are not being withheld periodically, the IRS requires you to pay quarterly tax estimates, usually due on the 15th day of April, June, September and January of the following year. Therefore, I recommend you save a portion of any payments you receive for taxes. The amount you need to carve out will depend on your specific business structure and income.

By the end of January, you’ll likely receive Forms 1099 for work you performed during the previous year. Companies that hired you and paid you more than $600 are required to issue a 1099. Review these to make sure they match your records. Your tax preparer will need all of these to properly file your returns.

If you hire contractors to work for you and pay them more than $600, you are also obligated to issue a 1099 by January 31 of the following year. Your tax accountant should be able to assist you with this.

At some point, you may want to hire employees. That could require a change in your business structure. It will also involve payroll taxes and insurance. Be sure to consult your tax and legal advisors before hiring anyone.

When working with your advisor, don’t forget to ask about the elective pass-through entity (PTE) tax. Many states have enacted an optional pass-through entity tax as a workaround to the federal $10,000 limit to the state and local taxes deduction. Specifically in California, qualifying entities taxed as S corporations or partnerships may elect to pay a 9.3% PTE tax on qualified net income. This PTE tax payment will reduce the federal net income included on the owner’s K-1, resulting in lower federal tax liability. Although the PTE tax is added back on the California return, owners will receive a tax credit to offset their California net tax liability.

Common deductible business expenses

Many business owners and consultants miss out on deducting expenses because they either are unaware the expenses are deductible or did not keep adequate records. For example, if you sell photos from your travels as a free-lance photographer, you may be able to deduct some travel expenses.

Below is a list of allowable deductions considered to be ordinary and necessary expenses for any trade or business:

  • Advertising/Marketing
  • Auto expenses:
    • Need mileage used for business purposes and total mileage for the year
    • Standard mileage rate is 58.5 cents per business mile driven for 2022
    • Actual expense (gas, oil, repairs and insurance)
  • Commissions paid
  • Contract labor
  • Insurance (other than health)
  • Legal and professional services
  • Office supplies and equipment (stationary, printer ink, computers, printers, desk, etc.)
  • Meals:
    • 50% deduction for business-related meals and food (For 2021 and 2022 only, 100% deduction for restaurant meals)
    • 100% deduction for employee-only events
  • Parking fees and tolls
  • Postage
  • Professional dues (renewal of professional license, union dues)
  • Travel and lodging:
    • You can expense travel and lodging when they are required for a bona fide business purpose and you are traveling away from the general area in which your business is located. This can be for meeting a client or attending conventions if you can show that your attendance benefits your business.
    • Some of the expenses you can deduct for travel include airfare, train ticket, taxis, Uber and lodging (if overnight). Note: If an airline ticket was obtained using frequent flyer miles, this ticket is nondeductible. Best to save your miles for personal travel.
  • Cell phone
  • Internet
  • Business use of home:
    • Simplified method: This is a standard deduction of $5 per square foot of the home being used for business; maximum 300 square feet ($1,500).
    • Standard method: Allocating a portion of home-related expenses towards business use by prorating based on square footage used for business versus the total square footage of the home. Expenses that can be deducted include mortgage, property tax, utilities and homeowners insurance.

Don’t forget retirement planning

Many retirement plan options are available for the self-employed. The right plan for you will depend on your business and retirement goals. Below are some of the most popular:

  • Ordinary IRAs — You can contribute to either a traditional (pre-tax) or a Roth IRA (after-tax). For 2022, the contribution limit is $6,000, or $7,000 if you’re 50 or older.
  • Solo 401(k)s — Also known as the one-participant 401(k), this plan works similarly to a corporate 401(k) but is only for the business owner without any employees (except for a spouse). Sole-proprietors and single-member LLC owners can make two types of contributions: an elective employee contribution up to $20,500 for 2022 (with a $6,500 catch-up contribution if age 50 and over), plus a profit-sharing contribution. The pre-tax contributions between the two types are limited to net compensation less 50% of your self-employment tax or $61,000 ($67,500 for age 50 and older). There’s an option to open a solo Roth 401(k), which may be a good approach if you expect your tax rate will be higher in retirement. Once the account has a balance of $250,000, annual filing is required by the IRS.
  • SEP IRAs — SEP stands for Simplified Employee Pension. As the name suggests, SEP IRAs are simple to establish and easy to maintain. The contribution limit is the lesser of $61,000 in 2022 or 25% of net compensation. Unlike the solo 401(k), you will have to file annually to the IRS. However, there’s no catch-up contribution and no Roth version. Many of our clients set up SEP IRAs and contribute the max amount annually.
  • SIMPLE IRAs — These plans are great for larger businesses up to 100 employees. The contribution limit is $14,000 in 2022, with catch-up contribution of $3,000 for those 50 or older.
  • Defined Benefit Plans — Contributions for these plans are calculated based on a few factors: your age, your expected investment return, and the benefit you will receive at retirement. These plans can be complex and costly, but they are great if you have high income and want to contribute large amounts into the plan. Some of our clients have used these plans to contribute more than $300,000 annually and receive a corresponding tax deduction. Similar to other tax-deductible plans, distributions in retirement will be taxed as income.

There are a lot of things to consider if you’d like to make the most of your professional skills and expertise as an entrepreneur. But by mindfully thinking through your goals, establishing a business plan and finding professional financial advice, your new business venture can be rewarding.

(Nick Lucas, senior associate in tax services at Aspiriant, assisted with this post.)