Dear Linda, I recently transitioned from being a salaried employee to a self-employed consultant. I like the flexibility but realize that I have more responsibility with regards to my finances. For example, I was previously enrolled in my employer's 401k plan and now I am not sure how to save for retirement. I am also confused about taxes - my employer withheld money from each paycheck but no taxes are being withheld when clients pay me. And people keep saying I can "write things off", but I am not sure what that means.
This transition can be confusing, but as long as you stay organized you will be fine. Here are some recommendations to help get you started.
Track all income & expenses related to your consulting work.
Open a separate bank account for business activity. Save all invoices and receipts relating to the business transactions. While not necessary, we also recommend using a bookkeeping software, such as Quickbooks Online, to generate invoices, attach receipts to transactions, and run reports that will help you at tax time.
Pay your taxes throughout the year.
You may need to calculate and pay estimated tax payments. Alternatively, you can increase your spouse's withholding if you are married and filing jointly. If you do not withhold or pay enough in estimated taxes you may incur a penalty. Work with a tax preparer if you have any concerns about the calculation or process.
Take advantage of "write-offs" and document your work mileage.
Deductions, or "write off's", are eligible expenses that reduce your taxable income. Examples include advertising costs, professional fees, and insurance premiums. You can also write-off expenses related to your work area at home as long as it is used solely for work. If you drive for work, you can deduct car expenses but a mileage log is required to justify the deduction. It is hard to re-create this at tax time so start keeping track now if it is something you plan to deduct. Leave a notebook in the car that lists the date, mileage and business purpose of each trip including the start and end location. You also need the odometer reading the first and last days of the year that the car is used for business (the tax return will ask for personal vs. work miles). There are phone apps that track mileage including one that links up to Quickbooks, so find what works best for you.
Continue saving for retirement.
Check with your financial planner to determine the best type of retirement account to use. Examples include the SEP IRA, Traditional IRA, Single 401k and Roth IRA. They all have unique characteristics and contribution limits so it will depend on your tax bracket, expected income, and other details relating to your personal situation.
Re-evaluate your personal insurance coverage.
Don't forget to seek out any coverage you may have lost when you transitioned to self-employment. Examples include medical, life and disability insurance.
This information is not a substitute for tax advice. We recommend speaking with your tax advisor if you have any questions relating to your particular situation. PWR offers Tax Preparation and Advisory Services. Learn more.
"Ask Linda" is a monthly personal finance column where the founder of Planning Within Reach, LLC, Linda Rogers, picks one question from her readers and publishes a detailed answer with the hope that it benefits others. If you would like to ask Linda a question, email her or contact her on Twitter.