This article covers two sides of the same coin for independent consultants: how to set up your business for success and what expenses to track to pay less tax. They're interrelated. Let’s tackle the tax question first.
What do I need to keep track of so I pay less tax?
Here’s a short list of the most important things and some tips to make it easier.
Have a dedicated credit card that you use only for business expenses. Use this card for anything you can think of related to your business, such as parking, tolls, cell phone, internet, office supplies, etc. Even if you work from home, what would you normally buy if you were in an actual office? These business expenses will be deducted from your gross earnings to lower your taxable income. If you can, pay your health insurance with this same card since it too will be tax deductible.
Tip: Download the credit card's year-end summary so you have a spending breakdown by category. Or you can download the transactions into a tool like Quicken each month and categorize the expenses there. (You’ll have to break them out by category on your tax return.)
Mileage. Ask your tax preparer if a mileage deduction or depreciating your car is the better option. For most people, deducting mileage expenses is the easiest. Try using an app like Mileage Expense Log, MileIQ, or TripLog for Android. If you’re more old-school, add a column to your timesheet.
Tip: Set a calendar reminder to write down your odometer reading on January 1 and July 1 every year. You’ll need these numbers for your tax return if you’re claiming mileage as a deduction.
Pay taxes quarterly! I know this sounds like a pain but you definitely want to avoid paying late fees. (More info below.)
Tip: Set recurring calendar reminders—PAY QUARTERLY TAXES—for the following dates every year. This will give you about 10 days to make the payments.
April 5 – Annual tax returns are usually due on April 15. An estimated tax payment for the first three months of the year is also due then.
June 5 – Quarterly tax for income earned April 1 – May 31 is due around June 15.
September 5 – Tax for June 1 through August 31 is due September 15.
January 5 – Tax for the last three months of the prior year is due January 15.
Those are the big-ticket items related to making taxes less painful, but the list is incomplete if you intend to be a savvy business owner.
What do I need to do to set up my business for success?
Note: I know many established independent consultants who could benefit from this info!
If you’re serious about your career as an independent consultant, you’ll want to distinguish yourself from someone who is simply between “real jobs.” We all know that image matters, so putting things in place to be professional will make a difference. Moreover, you’ll want to set up and manage your business in a way that makes accounting easier as well as taking advantage of valuable tax deductions.
Here are the steps to do this and tips to make it easier to deduct your business-related expenses on your tax return. One of the biggest advantages to being self-employed is paying less tax.
Choose your business name. Legally you don’t need one but you’ll appear more professional if you have one. Ensure the name is not already being used by checking the secretary of state website in your state. Do a web search similar to “available business names in Texas,” then look for the secretary of state website because it’s free; other sites are likely to charge a fee.
Check for an available domain name so that you can use a professional email address instead of your Gmail or Yahoo email. With many services your business email can be linked to your existing email account for about $10 a month. You may also choose to have a website although it’s not necessary if you have a complete LinkedIn profile. (More on this toward the bottom of the list.)
Determine your legal structure, for example a sole proprietor, limited liability company (LLC) or S-corporation. Click here for an overview but it’s a good idea to talk with a tax advisor about this.
Prepare and file organizational paperwork with your state if you will be doing business as anything other than a sole proprietor—for example as a partnership, LLC, S Corp, or C Corp. A service like Rocket Lawyer or LegalZoom can help with this.
Register a DBA (“doing business as”) with your local city/county if you will use a name different than your legal personal name or official company name that is registered with the state. (See prior bullet point.) Registering a DBA usually costs less than $100.
Determine your tax year. Most people use the calendar year instead of a fiscal year.
Determine the primary address and phone number for your business. While it’s easiest to use your home address, for privacy reasons you may want to use a P.O. box.
Get a Federal Tax ID number (EIN) from the IRS. Even though as a sole proprietor you're not required to have an EIN, it's a good idea to have one. You must provide an EIN or Social Security number to your clients, or the client will be required to withhold 28% of your payments. Having an EIN allows you to avoid giving your Social Security number to clients and other members of the public, helping to prevent identity theft. An EIN also reassures your clients that you're an independent contractor vs. employee. It’s easy and free to get an EIN online at IRS.gov.
Get a State Tax ID if you need one. If you have not classified your business as a sole-proprietor and you are not reporting all income on your Federal Form 1040 (for example, you're an LLC or S Corp.), get a State Tax ID number from your state’s government website. Do a web search on “State Tax ID California” or whatever state you are in. The fee will likely range from $50 to $150.
Investigate and obtain necessary business licenses and permits. The Small Business Administration is a good place to start. Fees for local licenses and permits can vary from nothing to more than $100 per year, depending on where you live. For example, a business license in New York City will cost more than in a small town in Idaho.
Set up a business bank account separate from your personal accounts to make tax preparation easier. If you're doing business as anything other than a sole proprietor the bank will need to see your business documentation from the state.
Get a new credit card for business expenses or earmark one you already have just for business purchases. This will make your accounting much easier since most of your expenses will be on this account. Use this credit card for as many expenses as you can, including recurring expenses like your cell phone and internet service and health insurance. (I recommend the tool at CreditCards.com to explore credit card options with no impact to your credit score.)
Investigate shared office space if you have trouble focusing when you work from home, for example WeWork or NextSpace. Simply do a Google search on “shared workspace near me.” Avoid a full-time or long-term lease so you can keep your expenses as low as possible, especially in the beginning when cash flow will be tighter.
Determine if you need business insurance or need to increase your personal coverage. Business insurance can be complicated; click here for an informative overview by CoverWallet.
Get business cards. They’re almost optional these days but still come in handy, especially at conferences and networking events. Affordable options are available online on many sites, including Vistaprint, MOO, GotPrint.com, or Staples.
Estimate your quarterly taxes so you know how much will be due every three months. (Learn how here.) Tip: To make sure you have the money at tax time, put 40% of every client payment into a savings account. After making your tax payment, put whatever is left into your SEP-IRA or solo 401(k) to really cut your effective tax rate. (More on that tax-saving magic is here. It’s one of the biggest advantages to being self-employed!)
Get in the habit of tracking your time, even if you bill by the project. Tracking your time by category (for example, client work, business development, administration, networking, commuting) will help you see how you spend your time. Anything that can be measured can be improved! Of course, there are apps for this too; Toggl gets great reviews but there are dozens. I recommend this review of apps for solopreneurs. If apps aren’t your thing, use an Excel spreadsheet. (Send me an email if you’d like a customizable template.)
Determine your marketing and positioning (how you “go to market”). For example, optimizing your LinkedIn profile for potential clients, creating your “tag line,” memorizing your “elevator pitch,” creating a Facebook page or Twitter account, building a website, etc.) My previous articles on this topic can be found here, and you can download the LinkedIn Reference Guide for Consultants for free here.
This may seem like a long list but building your business on a solid foundation is worth the effort. The phrase “Pay me know or pay me later” comes to mind. Set things up right from the beginning to save yourself headaches later. Additionally, keeping separate accounts for all business-related expenses will make your tax prep, including identifying deductions, much easier.
Be smart. Be professional. Be your best.