In my last article, I explained that self-employment tax is “buying” and paying for both halves of Social Security and Medicare. The total cost is $15.3% of every dollar earned. In this article, I wanted to share some different strategies for budgeting and paying the SE tax. Generally, if you work on a self -employed basis, you are expected to pay your estimated taxes on a quarterly basis.
Set aside tax money as soon as you get it
The very best piece of advice I can offer is just thinking that 15-20% of every dollar you bring in is “not my money” and putting that aside into a separate bank account. When you receive a check from a paying client for $100, deposit $80 into your active business account and deposit $20 into your “tax” account. If you get into the habit of setting aside 15-20% of every dollar you bring in, you find you have a reserve fund created and ready for paying the tax each quarter when it’s due.
The good thing about having the discipline to set aside money from every dollar you bring in is that depending on your overall tax situation, you might find there’s too much money built up in the tax account… Now you have a little slush fund of money that you can invest back into your business – purchasing a piece of equipment or something else that helps you increase your productivity.
Charge more for your work
The second piece of advice I offer is that you need to charge appropriately for your work. You have to know that when you are working on a self-employed basis, there isn’t an employer paying payroll taxes, and other overhead expenses. You’re the one who has to shoulder those costs. The hourly rate you charge for your work needs to be higher than an employer would pay you – just to break even. As an example, if an employer would pay you $30 per hour to perform a service under their employ, you need to be charging your clients a minimum of $36 per hour for the same work just to break even with the taxes. I’d actually recommend that you charge $40-60 per hour for the same work on a consulting basis, depending on your other business expenses.
Track every expense
The third piece of advice I recommend is being diligent about tracking your expenses. There are a number of software programs out there to help you track things. Posting EVERYTHING into programs like FreshBooks, QuickBooks, or Xero throughout the year helps you know at any point in time what it costs to run your business. Additionally, if you post regularly, you don’t have to try and dig through piles of receipts a tax time, trying to remember how a particular receipt scrap should be classified or wondering if you actually have saved everything.
Find a trusted tax professional
My final piece of advice is that you make a relationship with a tax person that you like and can talk with. Some people in the accounting profession can be a bit dry and hard to relate to, but there are those of us who really care about the experience of working with you. A tax person should want to help you build the best business you can. He or she can offer an outsider’s perspective that is helpful to consult when you get too far into your own head of running the business. Plus, most tax professionals have seen a variety of different business succeed or fail and can help give you pointers from those experiences.
Having a tax professional is having someone who can help you with overall planning for your tax situation. Different people have different tax experiences. Some file single, others are married. Different planning strategies can be employed when you have a couple where one partner is earning wages through an employer and the spouse is self-employed. Your tax person should be willing to work with you to look at your personal situation and set quarterly tax payments that align with your expected tax liability. He or she should be available for you to consult with each quarter or at any point through the year to review if your payments are on track for the expected tax for the year.
I hope this two article series has given you some perspective on what self-employment tax is and some ways to plan for it. Planning is one of the most powerful things we can do for our business and paying the taxes is just one component that you need to plan around. The more you understand and set a plan in place, the less surprising tax time can be each year.
If you liked this post, be sure to check out:
- Jessica’s previous self-employment tax post: Understanding Self-Employment Tax
- Being Boss Episode #103: Pricing & Money Management
- Our own CFO of Being Boss talks about how he approaches finances + money for business owners: Being Boss Episode #67: Work and Life Partners with David Austin