Setting up your business when you’re self-employed doesn’t have to be terribly complicated or expensive. But there are a number of details that you need to take care of. If you promptly attend to them, you’ll be off to a good start and be primed for self-employment success.
The first thing you should think about is how you want to legally own and operate your self-employed business. If you simply start working and don’t take steps to form a separate legal entity for your business, you’ll automatically be a sole proprietor. This is what most people do.
However, there can be advantages to forming separate entity to own and run your business. The most popular are limited liability companies (LLCs) and corporations. Forming one of these can limit your personal liability for business debts and lawsuits. In some cases, they can also save you on taxes. But there are down sides: Forming an LLC or corporation costs more than being a sole proprietor. And the limited liability you receive is often not as great as advertised.
EIN is short for employer identification number. This is the number you use to identify your business to the IRS and other government agencies. If you’re a sole proprietor, you ordinarily don’t need an EIN. You can use your Social Security number to identify your business. However, you have the option of obtaining an EIN. If you form a corporation or multi-owner LLC, it must obtain an EIN. If you form a one-owner LLC, you don’t need an EIN unless you have employees. You can get an EIN for free at the IRS website (irs.gov).
Depending on where your business is located, you may need to obtain a local business license. This usually just involves filling out a form and paying a fee to your city or county clerk or other official. Some types of businesses need state-issued licenses--for example, real estate brokers and salespeople must be state licensed. Be sure to obtain any licenses you need before you begin your business.
You should also consider whether you want to use a name other than your personal name (or the official name of your LLC or corporation) to identify your business. You can use a trade name, also called an assumed name, “DBA” (short for doing business as), or fictitious business name. This can be any name you want that is not already in use. To do this you need to register your assumed name. In some states, your register with your county government. Other states have state-wide trade-name registration.
Although not legally required, it’s always a good idea to set up a separate bank account for your business. Put all the money your business earns into the account. Pay your business expenses from this account and pay yourself from it as well. This makes business recordkeeping easier than if you use your personal bank account for everything. You should also use a separate credit card for business expenses. This can be a personal credit card you devote to business.
We live in a lawsuit happy world, and people love to sue businesses. That’s why many business owners need to get liability insurance to protect them from such lawsuits. Some self-employed people need special liability insurance--for example, various types of professionals are required to have professional liability coverage. You may also need insurance to cover your business property and insurance.
How much insurance you need depends on what type of work you do and where you do it. If you work at home and aren’t worried much about being sued, your homeowner’s or renter’s policy may be all you need. You can also purchase in-home business insurance policies that provide much more coverage. Another alternative is a more expensive business owner’s policy (BOP). Such policies combine both property and liability coverage.
It’s no fun doing recordkeeping, but it’s absolutely vital for all businesses. No matter how small your business, you need records of what you earn and what you spend. It’s particularly important to track your business expenses with receipts and other records. These are virtually all deductible—but you have to know what they are to deduct them.
Self-employed people often fail to do a good job with recordkeeping. But there is really no excuse for this. Readily available apps and bookkeeping software make business recordkeeping easier than it has ever been. For example, you can use smart phone apps to record receipts and to track your business mileage.
When you’re self-employed your clients and customers do not withhold any taxes from your pay to send to the IRS as they do with their employees. However, you’re not supposed to wait until Tax Day to pay all the taxes you owe for the prior year. Instead, you are required to pay your income Social Security and Medicare taxes to the IRS (and your state tax agency in the 43 states with income taxes) four times per year. These are called estimated taxes because you base them on an estimate of what your income will be for the year.
If you don’t pay enough estimated tax during the year, you’ll have to pay an underpayment penalty to the IRS. You could also have a huge tax bill due on Tax Day. There are various ways to calculate how much estimated tax to pay to avoid any underpayment penalties.
Almost everything you spend on your business is tax deductible. And business tax deductions can be worth a lot: They not only reduce your income taxes, but your Social Security and Medicare taxes as well. Every dollar in business expenses you deduct could easily save you 43 cents in federal and state taxes. The more you earn, the higher your tax bracket and the more deductions are worth.
Common deductions for the self-employed include business mileage, computers and other equipment, home office expenses, outside office expenses, business travel expenses, website and other marketing expenses, insurance, and legal and professional services. You can also take the pass-through deduction that allows you to deduct from your income taxes up to 20% of your net business income.