Last year, I fulfilled a lifelong dream: getting paid to tell jokes.
Every week, I cohost a comedy podcast about food (I’m not going to plug it, but it’s not hard to find).
The show is free, but we ask listeners to voluntarily subscribe and send us a few bucks a month, NPR-style.
Enough people enjoy our corny jokes and marginal food knowledge that last month we hired an assistant, Abby, who works a few hours a month for us as an independent contractor doing the dirty jobs: editing audio, keeping our calendar, untangling headphone cables.
Abby is new to the world of self-employment, but she’s far from alone. Self-employment, freelancing, and side gigs are everywhere.
And all of those independent workers, from plumbers to eBay sellers to podcast engineers, have something in common: in their first year, they’ll learn way more than they ever wanted to know about business taxes and licensing.
You see, as twisty as the US tax code can get for employees, you don’t get the full IRS experience until you file your first Schedule C, the form that goes with your 1040 when you run a sole proprietorship.
A lot of taxpayers are in this club.
In 2009 (the most recent data available), about22.7 million tax returns included a Schedule C. That’s almost 10 percent of all returns.
I’ve been self-employed since 2002, so I offered Abby some help.
Here’s a startup guide for your startup: how to stay out of tax trouble and get up to speed fast in year one.
Get a business license, or two
Not every business requires a license, but most do.
Mine requires two, because both the city of Seattle and the state of Washington insist. I pay $90 for my city license, but the state license is free.
To find out whether you need to get licensed, and how to start, visit the Small Business Administration and enter your zip code.
Lots of small businesses get away with running unlicensed. This seems like a risky way to save a small amount of money.
Learn about state and local filing requirements
This is my least favorite part of business taxes. (I realize this is like saying, “Root canals are my least favorite part of dentistry.”)
Washington doesn’t have a personal income tax, but it has sales tax and assorted other taxes for businesses. The city has its own array of taxes.
My business is small enough to exempt from most of these taxes, but I still have to file…four times a year.
Acquire an alias
If you want to advertise your business under a name other than your own, you have to apply for a fictitious name (great term, isn’t it?) or DBA (for “doing business as”).
It usually comes with a small fee. This is usually handled by the same state licensing agency that grants business licenses.
Obtain an EIN
An EIN is a federal Employer Identification Number.
Technically, you don’t need one unless you are a corporation, or you hire a W-2 employee or establish a 401(k) plan.
But you’ll need to furnish some sort of tax ID number to your customers, and without an EIN, you’ll be handing out your Social Security number left and right.
That can’t be smart, right?
Luckily, getting an EIN is free and takes literally seconds. Apply here.
Separate business from personal money
The IRS doesn’t require this for sole proprietorships, but you should do it anyway.
Maintain a separate checking account for your business, and don’t mix business and personal expenses in the same account.
It’s just too much of a pain to sort out at tax time.
Luckily, you have tons of options for a free checking account with no minimum balance.
This doesn’t mean you can’t move money between your personal and business accounts—of course you can! Just restrict it to transfers.
It’ll save you major headaches. I waited way too long to do this.
Set aside money for taxes
When you’re self-employed, no taxes are withheld from your pay, and you owe the federal government two kinds of tax: self-employment tax (Social Security and Medicare) and income tax.
If you don’t set aside money for taxes, you’ll get bitten with a high tax bill and possibly a penalty next spring.
If you expect to owe more than $1000 in tax on your self-employment income, you should start paying quarterly taxes by signing up for EFTPS.
I don’t even know what it stands for, but it’s the way to pay your federal business taxes online.
If your self-employment income is a small proportion of your total income, you can avoid quarterly taxes by adjusting your W-4 at your day job so you have more money withheld from each paycheck, enough to cover the tax on your small business income.
How much should you set aside? More than you think.
“Set aside between 25% and 40% of gross earnings to pay the estimates and the eventual balance due come next April,” says Andrew Stern, tax preparer and author of Z Art of Taxes.
Be compulsive about record-keeping
Document every business expense and every paycheck, no matter how small.
Use software such as QuickBooks to stay on top of it. Save (or scan) receipts, and use a credit or debit card for purchases—it’s much easier to document expenses made on plastic than with cash.
As Stern puts it in his book, “Try drawing a picture without red and blue on your palette. Or play a piano without the black keys. It’s the same trying to prepare your tax return without having all of the information at your fingertips. You will miss something.”
Don’t miss out on deductions
Do you use a cell phone or laptop computer for your business?
Even if the equipment isn’t used exclusively for business, you can deduct a portion of it.
If 25 percent of the time you spend on your laptop is spent on your business, you can deduct 25 percent of the depreciation on the laptop. Easy.
Consider the home office deduction
The same principle does not apply to your home office. If you want to deduct a home office, it has to be used exclusively for business, 100 percent of the time.
Think about whether this could work for you, though, because it’s a lucrative deduction, and the IRS simplified the process of taking it this year.
At tax time, use business-oriented software or a professional
Yes, small business taxes are more complicated than individual taxes. But it’s not a big deal.
I do mine every year with TurboTax Home & Business, and did so long before I started writing for Mint (which is owned by Intuit, makers of TurboTax and QuickBooks).
Think about retirement
Self-employment money adds to your bottom line, but none of it gets automatically get diverted into your 401(k), like your regular paycheck.
There are several retirement plans available for self-employed people, but for now just kick some cash into a Roth or traditional IRA—or up your contribution at your day job.
Just a few years ago, there were few good books on this topic. Now I can recommend several:
- Z Art of Taxes, Andrew Stern. A short, simple ebook by a guy who does taxes for rock stars.
- Working for Yourself, Stephen Fishman. For do-it-yourselfers, this book from Nolo Press covers more than just taxes.
- Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less, Mike Piper. Exactly what it says on the tin.
So, Abby, sorry to drag you into this mess. I don’t enjoy this stuff any more than you or any other sane person. But here’s the silver lining: keeping scrupulous records is good business practice anyway.
Now get back to to work!
Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.