Rupa Pereira
By Rupa Pereira
Do you enjoy being your own boss and having the independence, flexibility, and control in your work? If you said yes to the above, can you also manage variability, organization planning, tax planning and business development for your own small business?
Having an employer means having group benefits, health insurance, paid time off, sick leave and that regular paycheck that goes into your bank account directly. Scratch all that for the self-employed.
Self-employment, on the other hand, offers flexibility, control, and opportunity to invest in the business and in yourself – scratch all that if you are an employee.
It is a matter of tradeoffs and there are times in one’s career and life situation when one trumps the other. While employers limit decision making for salaried employees by offering them a menu of choices, the self-employed have to build their own menu.
To start off, you’re treated as a business owner which opens the possibility of building a business around your key strengths, eventually growing from self-employed to small business. Secondly, simply put, you have the creative freedom to build it your way. Financially speaking, you own the Balance Sheet, Cash flow and Profit and Loss statements for the business and as a business owner, you’re in the driver’s seat! Sounds scary, right?
But history has shown that wealth creation favors small business owners due to equity and financial control. According to Office of Advocacy of SBA, on average, the self-employed are wealthier than the non-self-employed. According to 2019 data from the Federal Reserve, business ownership is an important source of family wealth, representing 34 percent of non-financial assets.
Let’s delve into some planning considerations for sole proprietors or self-employed, mainly those showing their business income on their personal income tax return, i.e. gig economy workers, contractors, or independent consultants. They may receive either a 1099-Misc, 1099-NEC or 1099-K for services rendered. Or one may have both a W-2 and have a side hustle that classifies them as self-employed. This section focuses on a few planning areas for such self-employed professionals.
1. Maintain Books and Records
Separate business and personal expenses. Maintain book of records for income, credits, expenses and deductions because you’re considered a business entity, even if you’re a sole proprietor, so it’s imperative to operate like one. Keeping business finances separate from personal finances helps maintain legal and tax compliance. This separation simplifies financial record-keeping, making it easier to track business income and expenses, reconcile accounts, and prepare financial statements. It also allows auditors or reviewers to focus exclusively on business transactions without having to sift through personal finances, saving time and reducing the risk of errors or discrepancies.
2. Take Allowable Business Deductions
Sole proprietors can deduct business expenses that are ordinary and necessary to conduct their activity and that are reasonable in nature. A few of these include Home Office Deduction, Business Supplies, Transportation, Marketing, Professional Services, Legal Costs and Professional Development related costs. Again, having proper receipts and accounting will reduce audit nightmares. Speaking of business deduction, did you know that the self-employed health insurance (SEHI) deduction provides a valuable tax benefit for self-employed individuals who pay for their own health insurance coverage? It helps offset the cost of health insurance premiums and can result in significant tax savings. However, it’s essential to understand the eligibility criteria and follow IRS rules and guidelines when claiming the deduction. Moreover, self-employed individuals who purchase health insurance through the Health Insurance Marketplace may be eligible for the Premium Tax Credit if they meet certain income criteria.
3. Make Estimated Tax Payments
Since non-employees paid in cash/check don’t have withholdings similar to a paycheck, making quarterly estimated tax payments reduce the likelihood of a huge tax bill at year-end. Estimated tax payments also help spread the tax burden evenly over the year, reducing the risk of penalties since IRS expects tax obligations to be met whenever one gets paid. Making estimated tax payments requires self-employed individuals to estimate their tax liability for the year based on their income, deductions, credits, and other factors. This process can help them better understand their financial situation and plan accordingly.
4. Choose a Retirement Plan
Business owners have access to multiple retirement plans based on their preferences and business size. SEP IRA, SIMPLE IRA, Solo-401K are some of the popular options. Business Owners have higher contribution limits along with IRA/ROTH options. Each type of retirement plan offers different levels of flexibility in terms of contribution amounts, eligibility requirements, and investment options, so picking the right one will set you on path to saving for retirement while growing your gig.
5. Stay Unincorporated or Choose a Business Entity
A sole proprietor can be unincorporated and file Schedule C with their individual tax return. Thus, self-employed individuals are not required to have a formal business structure, but if one would like to eventually expand into a small business unit, then they need to consider liability protection, ownership and management control and costs to maintain the entity. When choosing a business entity, several factors should be considered to ensure that the chosen structure aligns with business goals, operational needs, and long-term plans.
In summary, as we’ve seen, whether you choose to pursue self-employment or traditional employment depends on individual preferences, risk tolerance, financial considerations, and career aspirations. Both paths offer unique advantages and challenges, and planning becomes extremely important, weighing income stability to flexibility and benefits to control and autonomy.
Rupa Pereira is the owner and lead financial advisor at FWJ Planning, an investment advisory and planning firm registered in NC. As an enrolled agent, she’s also authorized by IRS to represent her clients on tax-matters.
Contact: [email protected]
