As an independent contractor, you undoubtedly have certain highly desired skills. You turned those skills into a business. That’s to say, you don’t work for a company; you are a company.
As with any organization, your success boils down to numbers. And numbers mean accounting. Bookkeeping and taxes are two facets of accounting to pay special attention to. You don’t want errors or postponed/forgotten responsibilities to ruin what you are working hard to build.
Understandably, your busy schedule might require more time or thought for these accounting duties. However, you must find the time to gain the necessary accounting knowledge or hire an experienced business CPA to do the work for you.
In this blog, we’ll discuss some key elements independent contractors should know regarding bookkeeping and taxes. Then, you can better decide who will handle those functions.
Employees vs. Independent Contractors
Employees working for an organization have agreed to work certain hours for a set amount of compensation. They don’t get to make their schedule, and their pay is somewhat limited to what they agreed to work for.
If you are a contractor, on the other hand, you get to set your own agenda. Contractor pay is project-based, so the sky’s the limit with your clients.
However, there are trade-offs. Employers don’t maintain records of contractor hours; you must do that. No employer-provided health insurance. No worker’s comp. No unemployment benefits, bonuses, or company-funded retirement plan.
Taxes for Independent Contractors
And also, tax withholding isn’t done for you. It’s up to you to save some of the money you earned to pay the monthly, quarterly, and yearly taxes. That money goes towards personal and communal benefits like self-employment, Social Security, and Medicare. As a rule of thumb, save 30-40% of your income for taxes.
There are Forms 1099-NEC, 1040, and W-2s to consider, as well as schedule SE and C on certain forms. Learn more about those at IRS.gov or contact a local tax and accounting firm.
Cash vs. Accrual Basis
Independent contractors must also choose an accounting method to report on tax returns to the IRS. Cash basis accounting is the most straightforward. You recognize income when you receive it and expenses when they are paid. Sounds like there’s no need for a second kind, right?
Under accrual-based accounting, you’ll count money and expenses as you earn them, which isn’t the same as when you or bills get paid. Why would anyone want to use this method, you might ask? It allows contractors and their accountants to get a better look at the future of their business than with cash basis accounting.
Bookkeeping for Contractors
Contractors must maintain accurate and timely records that reflect what’s going on financially. Tracking earnings is usually top of mind, but it’s just as crucial to record expenses.
With few clients, single-entry bookkeeping usually suffices. Say you receive a check as payment from someone you do a job for. You then record that check in a database like Excel. Easy enough– payment received, payment recorded.
However, as you and your client list grow, you will want a more in-depth picture of your business. Double-entry bookkeeping gives you a better understanding of your company. For example, you might record your customer’s check in one database but your change in inventory in another.
Organized bookkeeping is vital for financial success. It’s how you and your professional accounting team can make educated decisions based on your history and turn them into a plan for the future.
Additionally, accurate data assists you in collecting money from your customers quicker (invoice customers faster to receive payment faster). It also helps you prove your case during a tax audit and lowers your tax burden when you can write off business expenses.
Other Items to Track
In addition to revenue and expenses, independent contractors want to maintain documentation on the following:
- Office rent
- Software or technology purchases for their business
- Hours worked on a project
- Profit (revenue minus expenses)
- Accounts Payable (what you owe and to whom)
- Accounts Receivable (who owes you money)
The above list contains just a few accounting items to track. An accounting firm offering bookkeeping services or a trustworthy accounting website can provide a more exhaustive list.
Separating Business from Personal
Don’t fall for the trap that you can use your personal bank account for business transactions. It’s best to separate the two for easier tracking when you need a clear picture of your revenue versus your expenses. It also makes taxes and auditing less complicated. It safeguards your assets (you aren’t dipping into your nest egg) and keeps you honest (you don’t try to sweep income under the rug).
Consider officially declaring yourself a business by creating your Employer ID Number. There are a number of savings and tax implications for doing so.
DIY It? Or Call the Pros?
Efficiency is everything! Manually entering revenue and expenses in a spreadsheet may work until your business gets busier. Investing in accounting services on the front end ensures you’ll stay efficient, law-abiding, and profitable from the start.
You can even start small and add on services as you grow. For instance, consider hiring a full-service firm for your taxes. Then, use them in additional ways as your client load increases, such as preparing cash flow statements.
Independent contractor accounting has its challenges, but contractors don’t have to manage bookkeeping, taxes, or financial decisions alone. Consult an accounting professional or firm who can help you establish a proper accounting system, making your business more successful.
