Being self-employed comes with lots of benefits, but one of the downsides is dealing with taxes. When you work for someone else your taxes are taken from your check before you even see it. But if you work for yourself, it's not quite so simple. Budgeting for tax time doesn't have to be complicated though. We'll show you how to save money for taxes.
The Ranks are Growing
There are currently about 15 million self-employed workers in America, but that number is predicted to nearly triple by 2020.
It's little wonder why. We increasingly desire more flexibility and work-life balance which being self-employed can provide. And when you make the leap, you might suddenly be amazed at how much more money you're bringing in every month.
Not so fast. You don't get to keep all that money! Uncle Sam still wants his cut. You have to budget for that. And because income for the self-employed tends to fluctuate, you aren't working with hard numbers but estimated ones. That makes budgeting for tax time even more important.
Four Times the Fun!
You know how everyone dreads April 15th, tax day? Well, for those who are self-employed, April 15th comes four times a year! The IRS wants you to pay estimated quarterly payments, a payment every three months.
This seems like a drag at first, but it's not really so different than an employer withholding taxes from each paycheck. And it saves you from being hit by one big tax bill at the end of the fiscal year. Silver linings people!
You Know It's Coming
We all know those people, or maybe we are those people, who wait for the last minute to do their Christmas shopping. So not only are they (or we) scrambling around at the 11th-hour shopping for the perfect gifts, but waiting until the last minute to do things also tends to make those things more expensive. You need gifts NOW! You don't have time to save up or compare prices or wait for a sale.
But how does this happen? Christmas has been on December 25th for a while now, yes? Yes. So it's not as if it sneaks up on us like a thief in the night.
The due dates for paying quarterly taxes are a little more free-floating than the date of Christmas, but not by much. The dates are mid-April, mid-June, mid-September, and mid-January.
How Much? That is the Question
Okay, we're all clear on the dates. The number you have to fill out on that check is a little harder to come by because, as we said, income for the self-employed is often inconsistent. If you live in Michigan and your business is lawn care, you aren't making as much in January as you're making in July.
So how much should you set aside for quarterly taxes?
The rule of thumb is 25-30% of your income. What!? I know, it sounds like a lot. It sounds like enough to send you screaming back into the job market. But consider this- "Taxes" encompasses a lot:
- Medicare Taxes
- Social Security Taxes
- Income Taxes
When you're traditionally employed, your employer pays half of the Medicare and Social Security taxes, and you pay the other half. If this seems like a bum deal, just remember all of the perks of working for yourself: setting your own hours, not having to get approval for a day off or vacation, no annoying co-workers. The list goes on. Feel better? Good.
Here's something even better. That 25-30% isn't based on your total income. You have all of those lovely write-offs! Home office, office supplies, client dinners, travel, advertising. With a clever accountant (also deductible!) the list is almost endless!
So your taxable income is not your total income but your income after expenses.
Getting Down to Brass Tacks
Everyone without exception needs to have a budget. We often think budgets are only for people living paycheck to paycheck, but that's not true. We've all read stories about sports stars or lottery winners who blew through millions of dollars in a few years. The one thing they all have in common is that they didn't have a budget.
When you don't budget, you don't know how much money you have or how much you spend.
The majority of our expenses are monthly, housing, transportation, utilities, etc. Some of them are yearly like Christmas and property taxes, but most expenses are not unexpected. (We should have an emergency fund for unexpected expenses- here's how you can start one).
Self-employment taxes are quarterly, so we build them into our overall budgets just as we would any monthly or yearly expense.
If your industry has widely fluctuating income, like the lawn care business example we used above, average the amount out of a twelve month period. Once you have the average monthly income number, deduct your business expenses from it. Err on the side of caution. It's far better to overestimate your taxable income than to underestimate it.
Once you have that number, deduct 25-30% from it. Again, it's always better to estimate too high than too low, so we suggest 30%. Now divide that number by 12. Whatever your number is, that is the amount you need to budget each month to pay your quarterly taxes.
Pretty simple really. It just requires a bit of math and planning.
It's So Worth It!
There can be a lot of scary things to consider when deciding to make the leap from a nice steady paycheck to going your own way, but budgeting for tax time should not be one of them. With a little planning, it can be the easiest part of working for yourself.
The best part of working for yourself? Let us count the ways. Independence, self-determination, the fulfillment of doing something you love, and the never to be underestimated joy of working in your pajamas! Uncle Sam doesn't care what you're wearing as long as you pay your taxes.