Over the last few chapters, we’ve discussed some of the slightly more abstract and theoretical aspects of providing a freelance service. We’ve seen how making small changes to your turn-around times, your wording, or your health can have big impacts on your ability to produce high-quality work and turn a profit.
But now it’s time to get practical again. It’s time to discuss the nitty-gritty details of running a business. That means taxes, legalities, contracts, budgeting, and more (oh my!). These aspects are not particularly fun, but they are, unfortunately, unavoidable. And it’s definitely worth spending a little time getting into good habits now if you want to avoid some far worse headaches down the line!
Billing
Okay, so we’ve looked at many of the collaboration tools that are used as industry standard by many organizations. But how do you go about sending and receiving money? This once again depends on the client and the situation, but there are a few “industry standards” that you will likely fall back on in the vast majority of situations.
PayPal
Perhaps the most common way to send and receive money online is through PayPal ( www.paypal.com ). PayPal basically acts like a middleman so that you don’t have to hand over your bank details to clients, and it also helps transactions go much more quickly and much more smoothly.
To use PayPal, you need to set up an online account using an e-mail address. Once that’s done, anyone can send money to you via PayPal and all they need is that associated e-mail. Better yet, you can even send money to someone who doesn’t yet have a PayPal account. Just send it via PayPal to their e-mail, and then when they associate the e-mail with an account, they’ll be ready to receive it.
To withdraw or add funds though, you’ll also need to associate add a bank account or credit card. To do this, you’ll provide your account information and PayPal will pay you two micropayments (tiny amounts of money). You then confirm the value of those microtransactions by checking with your bank statement and reporting back to PayPal, and from there you will be ready to start adding and withdrawing funds from your new account.
You don’t actually need to withdraw cash every time though. These days you can buy a lot of things with PayPal online, and you can even get a PayPal Debit Card for making real-world purchases! But if you’re working online for your full-time job, then you will probably want to withdraw your funds to a bank account eventually. Most mortgage providers won’t let you buy your house with PayPal, after all.
Likewise, PayPal will allow you to create invoices for your clients. This streamlines the process of requesting money, ensuring that they know precisely what they’re being charged for and giving them the option to make the payment very quickly and simply.
- 1.
Receive e-mail containing order.
- 2.
Acknowledge the order and commence working.
- 3.
Deliver work.
- 4.
Send PayPal invoice.
- 5.
Get paid within 24 to 48 hours.
This system makes getting started online incredibly simple and it means that if you have a PayPal account, you can potentially start earning money tonight and have it in your account immediately. Which is awesome.
More Features of PayPal
PayPal also comes with a host of other features that make life easier for you as an entrepreneur. For instance, it keeps a record of all the money that comes in and out of your account, which makes accounting relatively simple at the end of the financial year (more on this in a moment). It also lets you keep track of your invoices and bills, and remind clients who have yet to pay.
PayPal also integrates with a lot of other tools that you’re going to find yourself using as a freelancer. For example, it works with Bonusly, Fiverr, and a number of freelancing sites, meaning you don’t need to enter your bank details there.
For those interested in e-commerce and selling digital products, PayPal also lets you create Buy buttons that can be embedded in web pages, sales pages, or even e-mails. You can even charge for your services this way, especially if you ask for payment up front and sell them as packages.
Fees
Unfortunately, PayPal is not perfect, however. That’s because it does charge fairly high fees, which clients will often expect you to pay for. When you advertise your services as costing “$40 per hour,” your clients aren’t going to read this as “$40 per hour + PayPal fees.” This isn’t a problem though; you simply need to factor the fees into the amount you charge.
The fees are subject to change and can vary depending on a number of factors such as sales volume and the way you invoice. Generally though, they range from around 1.9% to 3.4%. Not negligible, but small enough that most people can factor them in without it crippling their operations.
Other Options
PayPal is probably the most widely used of these online payment services. There are plenty of others though, with TransferWise ( https://transferwise.com ) being one of the more notable alternatives. If you are put off by PayPal’s fees, then you may wish to do some research regarding these tools and see if one is better suited to your workflow. Just be aware that you might run into a little more resistance if the client doesn’t already have an account/isn’t already familiar with it (whereas you can practically guarantee they’ll be PayPal pros).
There are many other options when it comes to billing that don’t involve one of these sites at all. One is to simply ask for a bank transfer. This will normally be cheaper than getting paid via PayPal in terms of the fees. If the client is based in the same country, then it will probably be free. But if the payment is international, you may pay a flat processing fee plus a percentage on top of the overall amount being sent. The percentage will be lower, but the processing fee means that this won’t necessarily be advisable for smaller orders. Checks are also an option, though you might require a foreign check if you are providing services overseas, and that can again incur costs.
Note that a downside of accepting international checks and bank transfers is that they will often take longer to process. If you’re dealing with a new client and you haven’t quite established that level of trust yet, then taking a small hit in order to get your money sooner via an online portal might be a smarter option. I once dealt with a client who repeatedly told me that the money was taking a long time to transfer, or that the transactions were being cancelled by their bank. In truth, it transpired that they simply didn’t have the money to pay me and they were using this as a convenient excuse. I lost a lot of money as a result.
This is why the payment method will often evolve as your relationship with the client does. You might start out by doing the odd job for them and getting paid via PayPal and then “graduate” to a monthly long-term agreement where you’re paid quarterly via bank transfer.
With all that said, if your clients are based in the same country as you, then sending money via bank transfer or check (even cash in hand!) becomes the simplest option as long as you trust them with your account details. This way, you’ll pay very little in terms of fees and should be able to receive your payment almost immediately. At this point the only limitation is the need to log into your online banking to check that the payment has processed!
Bitcoin
Oh, and there is of course one more option: getting paid in Bitcoin. Bitcoin is a cryptocurrency that isn’t tied to a natural resource like gold or silver. Bitcoin is instead controlled by a public “ledger” called the blockchain and is protected via encryption. Bitcoin can be transferred internationally without fees, and has historically risen in value immensely, making it a potentially attractive investment opportunity. Bitcoin and other cryptocurrencies can also be spent and invested by bots and scripts, creating the possibility of “algo-businesses” that entirely run themselves.
At this time though, Bitcoin is largely only accepted online (save for a few media-savvy pubs and other venues). It also requires a little bit of setting up in order to start trading. And if the client you’re approaching doesn’t know what Bitcoin is, they’re unlikely to want to spend time learning about it in order to pay you that way.
However, if you’re familiar with Bitcoin and your client is too, then it’s certainly an interesting option. And one that is likely to become increasingly viable in the coming years.
Invoicing
It’s also a common practice to provide your clients with an invoice. This helps them with their own tax reporting (discussed later in the chapter) as your services will be written off as an expense/overhead. At the same time, it also inspires trust by demonstrating complete transparency. They will appreciate getting a complete breakdown of all the services provided and how much each cost, for their own records, to show to their superiors, and in case they have any questions or issues with the work you provided.
How you go about writing your invoice is largely up to you, but you should aim to make it as professional as possible without spending hours on it. Remember: time is money.
This is another benefit of using a tool like PayPal, seeing as it has the option to send invoices built in. You simply fill out the services/goods provided, their quantity, and their cost per unit and then you click Send. The recipient can easily pay that invoice and also keep a record of it.
Otherwise, you will likely need to make something yourself using a PDF. Microsoft Word now allows you to convert documents to PDF simply by saving them in that format. So, you can create a table including each job/project and the cost, with a total payable down the bottom.
Your name
Your company name
Your address
Your e-mail
Your phone number
The date
The invoice number (if you deal with the client regularly)
Your PayPal address OR bank details
A logo (if you like)
Sample invoice
This is an actual invoice I sent to a client recently (with a couple of changes) charging for a few hours of work on each of those days. Of course, if you wanted to charge per completed line of code, or per finished project, then your invoice would reflect that.
Even if you are providing a B2C service selling personal training services (meaning they aren’t likely to need it for their tax reports), an invoice like this will still be appreciated by your clients.
Currency
When billing, it is a common practice to charge in US dollars—regardless of what country you’re in. This is the “currency of the Web,” and while you can charge in your local currency, it will only lead to confusion.
Of course, what this also means is that your income is going to change a lot depending on the exchange rate. When the value of the British pound falls against the dollar, this can result in a hefty pay rise for me at times. It’s a little strange for me, but I benefit when the economy struggles! On the other hand though, if things move the other way, then this can hurt my income.
This also means that you can potentially benefit a lot financially by moving to a different country. If you are being paid in dollars and you move to a region where the dollar is worth more, you can withdraw your cash and potentially live like a king. More on this in Chapter 8.
This is also a factor you need to consider when choosing your payment method. Depending on the service you choose, you will be offered a different exchange rate. PayPal’s exchange rate, for instance, actually hides additional costs—the rate it offers is the “wholesale cost of foreign currency . . . plus a currency conversion fee.” This is a mark in favor of TransferWise, which actually charges the mid-market rate in its conversion, plus a relatively small and simple flat fee.
Anything currency is acceptable, as long as it is agreed by both you and the client, and as long as you factor these potential extra costs into your budgeting and financial modeling. You may even find that you end up charging in dollars, but then converting that amount into your local currency when you bill the client. That way you can benefit from the exchange rate where it is in your favor without paying a conversion fee. If you find such a client, then stick with them!
Agreements, Contracts, and Monthly Payments
Another factor that is going to impact the way you get paid is the way in which you arrange your agreement with your client.
Earlier in this book, I recommended going after gigs that will pay immediately at the end of the day. I also mentioned that I prefer getting paid “per quantifiable unit.” That’s one option, but then there’s the option of agreeing to a contract where you will work a certain amount per month/week/day. This might then result in a recurring monthly payment, as long as all the work gets done. As mentioned, you’ll find that this type of agreement often “evolves” from a more casual working relationship and that this lends itself better to bank transfers. If there’s a $15 flat fee for sending payments, that’s going to be a much smaller issue when the total payment amount is $2.5K versus $50.
This type of work has other benefits too, as it means that you have at least some kind of stable and predictable income. It’s a great feeling knowing that even when the clients aren’t biting, you have at least some income guaranteed. And it can really help with budgeting. If you mix this with other types of agreement, then it can help to further diversify your client roster and create a more resilient business.
But of course, it also robs you of some of your flexibility and freedom, as it means at least a certain portion of your time is going to be already assigned at the start of the month. It also puts the power in the hands of the client once more—they’re tying you down and setting the terms, and you’re then agreeing to them. This is subtly different from you offering to provide website maintenance for a recurring monthly fee or for a one-off bulk purchase.
Precisely what is it that you are agreeing to? Usually this will be X amount of work per given period.
What agreement is in place for when you fail to meet those targets?
How is payment agreed?
What happens if the client fails to pay?
How soon will they pay once they have received your work, or on what day will they pay?
How long is this contract valid for?
If this is a recurring monthly agreement, then how will either one of you bring it to a close?
If you are agreeing to complete a certain long-term project (another common use for a contract), then what is defined as “complete”?
Who retains the rights to the finished work? How will they/you be allowed to use it?
Look out for other things that the client might try to sneak in there too. Some may try to prevent you from working with competing parties, which could end up limiting your ability to find other clients.
I often find it is the client that is most likely to write up the contract, at which point you are that little bit closer to being traditionally employed. You’ll likely find this contract is developed with the help of software like the aforementioned DocuSign. If not, you might be sent a PDF that you can sign with a digital stylus, or that you can print out, scan, and return. If you’re unsure, then ask someone with legal knowledge for their advice.
While I don’t like handing over power to clients like this, it is very often a necessary evil in order to secure the best work.
Other Types of Contract
You won’t only be signing contracts relating to the work you’re providing. You might also be asked to sign contracts relating to nondisclosure agreements (NDAs). This means you promise not to discuss the nature of the work; this may be necessary if you are working for a client that is planning a big project and doesn’t want the details to be leaked to the press or the competition.
Normally an NDA is something you can sign safely, though there are some examples of companies using them incorrectly (to prevent whistle blowing for instance). Again, it’s worth a thorough read before you sign.
Another common form you might get from foreign clients is to confirm that you are based in whichever location you’re based in (this is sometimes necessary for their tax purposes). For instance, if you provide work for a client based in India, then they may need to document that you are not based in India via a Tax Residency Certificate (TRC) Declaration or similar. You might be required to get the form yourself, or you might be sent one to fill out. The same rules apply: make sure you read the document carefully before signing. Foreign clients might also request that you send a scan of your passport or other documentation proving citizenship. This can feel a little invasive, but if you trust the client, it shouldn’t be a problem.
Be cynical and very careful, but don’t let that sour what could otherwise be a fruitful relationship with a big client.
Writing Contracts
Should you decide to write the contract yourself, then stay calm and don’t panic! While anything “legal” can seem daunting, the fact of the matter is that this is actually quite a simple process. Your objective is to write out the agreement that you want your client to accept, in such a way that it is crystal clear what you are both agreeing to, with no room for alternative interpretations.
Try to keep your contract as short as possible. Respect the client’s time by not asking them to read through 20 pages of fine print for the sake of a two-hour job. If you need a little help, then ask a pro or consider looking for templates online; there are plenty available!
Most contracts will include the following:
Overview
This is a little like the “upside-down pyramid” approach to writing a news story. The first objective is to succinctly describe who the contract is between (including company names and addresses), to summarize the project/agreement, and then to outline the cost. This is your abstract, or your statement of intent, and you can expand on this later in the document.
Responsibilities
You should also outline what each party is agreeing to. That might mean “sticking to deadline” or “paying on time.” You should also include what you aren’t taking responsibility for. For instance, you might agree to build a website but not to upload it to the server or secure a domain name. Expressly state that your client will be responsible for that side of things.
Scope
Similarly, the scope will include all deliverables. Precisely what is the client going to receive and, by extension, what are you agreeing to provide? Make this as explicit as possible. Likewise, be sure to leave room for changes and alterations, however: Will the client have the opportunity to request revisions? How many times? How will such changes be requested?
Ownership
Intellectual property is an important consideration. Does the client own the exclusive rights to the project? Or do you maintain the right to sell this same work on to other clients in the future? Can you use part of the work you’ve provided to the client? Do they need to credit you for your contribution?
Payment Plan
If you are asking for an up-front deposit, followed by a final payment on receipt, then this would be where you outline that. The same goes for smaller, more regular payments and other payment variations.
Warranties
Do you offer any guarantee with your work? What if there are errors in your code? How long will you offer troubleshooting? Is there a money-back guarantee?
Termination
What will happen if the project doesn’t go to plan? How and when can either party pull out of the agreement, and what penalties are incurred for doing so?
Signatures
Of course, you should also include a space for the signatures of both parties. These should also be dated.
Not all contracts require signatures though. In their absence, this will not be binding and will work more as a written informal agreement that serves simply to keep everyone on the same page.
Either way, writing out contracts yourself is generally preferable as it means you get to define the terms of your relationship and keep the balance of power shifted in your favor. Then again, you’re still agreeing to do something in a very specific way, and based on terms you have agreed with the client, which is always going to be somewhat restrictively. Personally, I prefer to work contract-free wherever possible as it gives me more flexibility.
Keep in mind as well that the protection a contract provides you is only valid if the contract is legally sound and if you are actually willing to take action should the client be in breach! Certain clients will ignore their own contracts and very often it’s not worth your time pursuing them. So, while this does offer a little assurance, know that you’re not completely safe!
Tax
Okay, now the bit that you’ve been dreading. Get used to that feeling, because you’ll be dreading it every year!
If you are self-employed, then that of course means you’re going to have to handle your own tax returns; either on your own or with help from an accountant. Either way, this can be stressful, for obvious reasons: you’re spending a large amount of money, you can get into trouble if you get it wrong, and it can get quite complex.
Of course, the specifics of how tax is reported and collected is going to vary depending on your location. For that reason, I don’t want to go into granular detail explaining how to fill out each form or what can and can’t be claimed. What I am going to do is explain the basics of how tax works for the self-employed and provide some tips that I hope you can use to make life easier and help you to better account for the impact tax is likely to have on your margins.
How Tax Returns Work
First, for the completely uninitiated, let’s go over how tax returns actually work and what it means to “take reductions” or “claim back” on your tax. Do you pay less tax? Can you get things for free?
In short, you are going to be taxed on your net profit. It doesn’t matter how much money comes into your business; what really matters is how much money you get to keep at the end of the day. So, if someone pays you $1,000 to build a website, but you hire a designer to help for $200, then you’re only going to be taxed on the remaining $800. (Except you need to multiply this process and calculate your total profit for all the jobs you completed that year.)
While you’re only going to be charged for profit, you do need to know your other numbers—such as how much money came into your business (called your revenue).
Your revenue (total amount paid to you)
Your expenses (total amount spent on equipment, services, supplies, etc.)
Your profit (revenue minus expenses)
You’ll report this at the end of the tax year (April 15 in the United States and April 5 here in the UK) for the year preceding. In the UK we report to the HMRC ( https://www.gov.uk/government/organisations/hm-revenue-customs ), and in the United States you’ll be making your payments to the IRS ( https://www.irs.gov/ ) using Schedule C of Form 1040. Don’t expect these websites to resemble anything made in the post-Geocities era.
Depending on your region, you will be asked to pay an amount of tax based on this profit. In the UK, you can earn up to £11,500 without any tax. Anything over that up to £45,000 will be charged at the “basic rate” of 20%, anything over £45,000 up to £150,000 will be charged at a higher rate of 40%, and anything beyond that is charged at 45%.
So, let’s say that you had a revenue of £70,000 (well done!), but you spent £10,000 on computer equipment, software suites, website membership, and advertising (very convenient round numbers here). You’ll report both these numbers and you’ll be left with £60,000 as your profit for the year. You will pay no tax on the first £11,500—so that will leave you with £48,500 taxable income.
You’ll be paying 20% on £33,500 (so that’s £6,700) and you’ll be paying 40% on the remaining £15,000—which will be £6,000. So, you’ll pay a total of £12,700 income tax for the year.
If your total profit was £60,000, then you are now taking home £47,300 after tax.
In the United States the system is very similar, though the precise numbers are different. There are seven different brackets: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. These numbers actually vary a little for single professionals versus those with “head of household” status. Ultimately though, you’ll still be left with a similar amount of income “after tax.”
Except you likely won’t get to see all of it, as you’ll also likely need to pay things like National Insurance contributions in the UK, SECA Self-Employment Tax in the United States (which includes Medicare and Social Security contributions), student loan repayments in the UK (which also normally increase inline with your total earnings), and so forth. In the United States, you may also be required to make payments to your state tax agency, meaning that the total amount of tax you pay can vary from one state to another.
While you can calculate all of this yourself prior to filing your tax return, it does actually get a little difficult to account for all these different factors and it is one of the major headaches of being self-employed. There are calculators online that can help, or you can make do with a rough estimate. The good news is that when it comes to reporting, you should only need to input your revenue and overheads, and the relevant website will do the rest. If you choose to file your tax return manually by hand (or if that’s your only choice), then things might be a little more complex.
Again, I don’t want to get into the nitty-gritty here as it’s all subject to change anyway. The best advice then is to check the government web pages and then to follow the guidelines you find there. You can also try speaking with an accountant or financial advisor if you need a little extra guidance, or perhaps a well-informed friend.
You get taxed on profit, not revenue, though you need to know your revenue too.
Tax increases incrementally as you pass certain income thresholds.
Even the highest earners will pay lower tax rates up to those thresholds—only the excess income is charged at the higher rate.
There are other things to pay when you file your return such as national insurance contributions etc. depending on your location.
How you then pay will also vary from region to region. In the UK, you can pay by card, direct debit, or check. You can do this online, by post, or over the phone. Generally, you will pay your tax in two installments: halfway through the tax year, and then again at the end. The first payment is calculated based on your earnings in the preceding year (the assumption being that you will have earned the same amount), while the second payment is known as the “balancing payment” once your tax return has been submitted. This is when you will pay the difference based on how much you actually earned. For this reason, you won’t pay any tax at all until you’ve worked for at least one whole year. Again, things are different depending on where you live, and in the United States you will pay FICA and estimated taxes quarterly.
Depending on your location and preference, it is also possible to pay tax at alternative intervals. For instance, you can choose to use PAYE (Pay As You Earn) in the UK and pay monthly tax contributions as though you were employed. That said, the changing nature of your income means that you will still need to pay a balancing amount. It is also often possible to pay deposits into your online accounts, so that you can space your payments out throughout the year in a manner determined by you.
Keep in mind that it is usually better to keep money in your own accounts as long as possible. This way, you can still make interest on that money, and you will have easier access to it should you have an unexpected expense.
For those in the United States, you can find all the information you need at the IRS Small-Business Tax Centers page ( www.irs.gov/businesses/small-businesses-self-employed/tax-centers ). The Small Business Administration (SBA) is also a very useful resource: this is a US federal organization created to help small businesses learn what they need to pay. You can find that here: www.sba.gov . SCORE ( www.score.org ) is also a useful resource as a not-for-profit, free business-mentoring and education network.
For UK-based businesses, Gov.uk has a useful guide to setting up as a sole proprietor here: www.gov.uk/set-up-sole-trader .
For everyone else, a quick Google search should help you to find similar resources relevant to your location.
Claiming Expenses
There is a little bit of misunderstanding and misconception surrounding the concept of “writing off/claiming expenses.” Many people seem to think that being self-employed means you can get all sorts of things for free by “deducting them.” This is definitely not what’s going on!
What deducting expenses really means is that you are going to file something that you have purchased as an overhead/expense. In other words, it will be subtracted from your overall revenue and not included as profit.
So, if you buy something like a laptop that you are going to use for work, you can “write this off,” meaning that it won’t be counted as income. If I earned $35,000 and I bought a $2,000 laptop, then I can claim for the laptop and my profit will now be $33,000 rather than $35,000.
So, I don’t get the laptop free, but I don’t need to pay tax on it. And seeing as I would have had to pay 20% tax on said laptop, that means I could make the mental argument with myself that it is in fact costing me $1,600 rather than $2,000. While there was no money deducted from the laptop itself, I’m still paying $400 less tax than I would otherwise. So, this becomes a much more calculated expense for me. (Just switch the currency and the rate and the same will be true for wherever you are based.)
The nice thing you may have already have noticed is that we are in fact now paying “less tax” than our traditionally employed contemporaries. That’s because there’s a good chance you would have had to buy a laptop anyway. Being self-employed means you can get a nicer one, or pay less overall. Most employed people have a personal laptop/computer they use for browsing Facebook, chatting with friends, watching movies, playing games, and writing documents. As someone who is self-employed, you can make your work laptop double as your home laptop and claim it on tax.
The same goes for a lot of other things, including your mobile phone contract, portions of your electricity bill, your Internet service provider’s bill, even your rent! In most areas it is permissible to deduct some of your rent from your taxable income, as long as you calculate what percentage of your home is devoted to work activities.
Again, you likely don’t have a bigger house than you would have had otherwise, and therefore you are paying less tax than your friends. And it’s all perfectly by the book.1
But this is also where things start to get a bit complicated and a bit muddy—what is an expense and what isn’t? Should you claim everything you possibly can?
Dangers of Claiming Too Much
It’s important that you read carefully what you can and can’t claim as an expense. Depending on your region, this is going to vary drastically. For instance, in the UK it was once possible to claim back any money that you spent on “entertaining clients.” That meant that you could take a potential client out to dinner and not pay tax on the cost of that meal for you or for them.
But then a lot of people began to take advantage of this (by paying for meals for their family and pretending they were potential clients) and so a few bad eggs ruined it for the rest of us. Today, “entertaining clients” is no longer a valid expense in the UK.
In reality, you can usually get away with blue murder as long as you aren’t taking the mick, seeing as no one is going to check your expenses. In fact, in the UK at least, you don’t actually have to show your expenses at all! You can simply upload a single number for your overheads and be done with it.
BUT there is the possibility of being audited, in which case you will suddenly have to explain where all that money went. The burden of proof is now on you to demonstrate what each expense was.
That means you are going to need receipts. And if anything is dubious (such as money spent on coffee in Starbucks), then you’re going to need to demonstrate why it was a necessary expense and not a personal expense.
In the UK, you need to keep tax records for at least five years. This can be pretty painful as it means you’re going to need a good filing system capable of storing five years’ worth of receipts. Fortunately, in the United States it’s a bit less stringent and you only need to maintain your records for three years.
As you can imagine, getting audited is an incredibly stressful and invasive experience and can result in your needing to make large amounts of back payments. It’s much better not to push matters and not to draw undue attention to yourself! Then of course there is that whole moral angle. After all, you use the same services as everyone else and you’re already getting some perks from being self-employed. It only seems right then that you should pay your fair share.
Even if none of this is of concern to you, there are still reasons it isn’t particularly wise to claim everything. For one, when you claim a lot of expenses, that means that your official income is lower. Your tax return is the only demonstrable proof of your income, and so this can then make it hard to claim a loan.
So if I were to earn $70,000 one year—a very healthy sum—but then went overboard and invented $50,000 of expenses, my tax return would say that I only earned $20,000! I might think I’m very clever, until I go to the bank to try and get a home loan. They’d see that my income was only $20,000 and thus they wouldn’t offer me the amount I needed to buy my dream home.
Our aim then is certainly not to push this as far as it will go. In fact, I personally prefer to keep my reported expenses very modest. That way, if I should miscalculate, I know I can still explain my workings. Not only that, but as a sole proprietor who works in tech, my overheads are legitimately very low. Rather than stressing about every receipt for the sake of a few quid (Brit-talk, sorry), I would rather pay a little more tax and avoid the stress. To be honest, the amount of time it would take me to count every train journey to attend a conference could be better spent just earning more money. I see this the precise same way as communication overhead.
Plus, it does go to a good cause. For the most part.
(Translation: If you work for the HMRC, please don’t audit me . . . I’m good, honest!)
Some Common Expenses
Chances are that if you are a tech entrepreneur, or a B2C service provider working online, your expenses won’t be all that high. So, what could you claim?
Here are some common categories that might constitute “expenses.”
Equipment
The number one expense that many of us will have in the gig economy is our equipment. That’s likely to mean a laptop (which is always fair game), but it could also mean things like webcams if you provide Skype coaching. Or it could mean things like graphics tablets if you are a designer, or a smartphone if you use it for your business.
Software
If you use Adobe Creative Cloud, or perhaps an IDE for coding that charges you a one-time fee/monthly subscription, then this can of course also be written off as an expense. Other examples might include virus protection, or Microsoft Office.
Marketing
If you are going to advertise your business via a pay-per-click (PPC) campaign, or even a magazine ad, then the money you spend here would be considered an overhead.
Premises
As I briefly mentioned, it is possible to claim a small portion of household bills back as a sole proprietor. That might mean a percentage of your electricity bill, your phone bills, your Internet service bill, even your heating bill and rent. This will be based on a calculation that takes into consideration the amount of space that is dedicated to work, and the amount of time you spend working there.
Of course, if you do happen to rent an office, or if you spend money to work in a co-working space, then that is fair game for a deduction too.
Supplies
Ink cartridges, paper, paperclips, packaging . . . keep your receipts!
Mileage
If you drive to meet clients, or get the train to attend a tradeshow, then this can be claimed back too.
Loans and Bank Charges
If you have taken out a business loan, or a PayPal loan, then you can claim back the interest paid. And if this loan was spent 100% on your business expenses, then of course you can claim back the entire amount very easily too!
Likewise, you also don’t need to pay tax on the fees that PayPal charges, or any other bank fees.
Services
You can claim back any services that you use in order to provide your own work. For instance, if you are a coder but you use a designer to create graphics, then you either charge the client for that expense or you can include it in your price but then claim back the overhead.
VAT
VAT is value-added tax and is something you will need to consider if your turnover exceeds a certain amount. Here in the UK, that’s set at £85,000 per year. The US has something very similar called ‘Sales Tax’.
VAT is a “consumption” tax that is added to products and services at every “point of sale” where value has been added.
In other words, if money has exchanged hands, then you can bet the seller is going to be required to charge VAT and then remit that to the government. Normally, this VAT charge will be passed on to the buyer.
So, if your business model involves buying wholesale goods, then selling them on to client, you’ll need to pay VAT to the wholesaler because they have provided value, and you’ll also need to charge VAT to your own customers because you’ve added value by making the goods available and delivering them. In the UK, VAT is set at 20%.
In the United States, Sales Tax is charged at the state level rather than federal level. This means it varies between states, anywhere from 1% to 16%. Tax is not usually added when products are exported to other countries, however.
As a consumer, you will likely have experienced VAT as a nice surprise when you reached the checkout. Companies often don’t like declaring the VAT charge up front as that isn’t the amount “they” are charging as such, and they don’t feel that they should have to scare away their customers with what looks like a 20% higher cost. It’s up to you how you want to play that.
If your turnover exceeds the VAT threshold in your location, then you will need to register for VAT and then charge your customers for the goods and services that qualify for VAT. BUT you will also get the nice bonus of being able to reclaim VAT that you pay on goods and services yourself.
Types of Business: Sole Proprietor vs. Business Entity
If you are self-employed, then you are technically a business owner. Congratulations! Even if you just cut your neighbor’s hair, that still counts.
But there are many different types of business owner that you can be. In that example, you would be what is known as a “sole trader” or “sole proprietor,” which means you are a single entity who provides a service or product and doesn’t usually employ any staff (though this is not a requirement). If you are a tech entrepreneur planning to build websites, provide coding, or write articles, then chances are it will make the most sense for you to register as a sole proprietor.
Registering as a sole proprietor is much easier and more straightforward than setting up other types of business. Registering as a sole proprietor in most cases means nothing more than registering yourself to start paying tax i.e. registering as self-employed. There is no additional separate process required. Here, you are the business in a legal sense. It is not a separate entity. That in turn does mean that you inherently take on a little more risk. There is no such thing as your “business going bankrupt” . . . that just means you are going bankrupt! But it also explains why it is so much easier to set up from an administrative standpoint, whereas becoming a limited liability company is a significantly more confusing task.
Becoming Limited/Incorporated
Here in the UK, the most common next “step up” from being a sole proprietor is to set up a limited business - the close US equivalent of which is the limited liability company. A limited liability company will have the suffix LLC (or LTD for a limited business), and that essentially refers to the “limited liability” that the individual has for the company’s debt. The owners will pay income tax, while the company itself will pay corporation tax. The responsibility for the company’s debt is normally limited to the amount that the owners have personally invested.
In the United States, it is also common to see the Inc. suffix, which refers to an “incorporated” business. An incorporated company will act as an entirely separate legal entity. That means that money owed by the business will not be owed by the individual. Your finances will also be separate, and rather than keeping all of your income, you will need to set yourself a salary.
There are several benefits of being a limited or incorporated business. For one, you will be taking on less financial risk. Any loans will be repayable by the business rather than by you personally, and if your company should file for bankruptcy, it won’t affect you in the same way. While sole proprietors normally can take on employees as long as they file the right forms and pay the right bills and taxes, it is easier to do this as an LTD or Inc. Apart from anything else, this will protect you legally from lawsuits that employees sometimes like to launch at their employers!
Likewise, it is easier for an incorporated businesses to take on certain types of client. Some clients might feel adverse to taking on sole proprietors for instance, as they run the risk of becoming viewed as employees (which then means more expense and legal work for the “employer”). If you work full time for a single company, you might legally be forced to register as employed rather than self-employed. This is something to keep in mind yourself: you can’t “freelance” for just one client!
Finally, the clear divide between you and your business will make tax reporting a little easier in some cases—as it will be very clear what was a business expense and what was a personal expense.
There are more fees associated with setting up either of these types of business, however, as well as significantly greater administrative challenges. That’s why many people will choose to keep things simple - at least to begin with - by remaining as a sole proprietor.
A limited liability company (LLC) is usually effectively a partnership: a business that can have multiple owners (called “members”). An LLC is less complex than a corporation but still needs to offer stock and it still pushes you further on the spectrum toward “administrative nightmare.”
The next “step up” from being an LTD or LLC is to become a fully fledged corporation. At this point though, you’re getting away from what we would traditionally call gigging!
Independent Contractor
Another option for freelancers is to become “independent contractors” (defined by the IRS here: www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-defined ). This means that you are working on a per-contract basis, and if you consider the “evolution” of working relationships with clients, this is basically what is found at the extreme end—where you are more committed to a single company but are not “employed” by them technically.
Independent contractors are still considered self-employed but may pay their tax differently and may or may not receive benefits from their employers such as sick leave, maternity leave, and so forth. Contractors can work for more than one company at a time, or might change organization on a month-to-month basis. The problem is that very often an employee will work solely for a single company over the course of several years and still be misclassified as an independent contractor. In other cases, the term independent contractor is effectively interchangeable with freelancer and has little actual impact on the way you work.
According to the IRS, “misclassification” of workers is rife, and this is actually one of the bigger dangers of the gig economy as a whole. Companies often feel it is in their best interests to misclassify their long-term employees as contractors, as that means they are not required to pay their Medicare and Social Security contributions. It also means that they can avoid having to offer holiday pay, health insurance, company pensions, dental coverage, and other benefits (though some will still offer this). It also means that an employer can let the contractor go at the end of their contract without explanation.
This is where companies like Uber, FedEx, Grubhub, and similar have faced criticism and legal challenges. And it very often leaves the contractor in an unfavorable position, as they find themselves with all the drawbacks of being employed (no flexibility, requirement to work set hours) and none of the benefits (sick pay, job security).
The gig economy is potentially incredibly beneficial to those of us that are willing to take responsibility for our own income, time, and budget. The danger is that it also makes it possible for companies to take advantage of their employees, especially those that are nervous to go “all in” and are tempted by the seemingly favorable compromise offered by a long-term contract.
The key, as I have said already multiple times throughout this book, is to make sure that the balance of power is firmly in your court. And this will depend on everything from the way you communicate to the way you structure your business.
Company Name
If you’re a sole proprietor, then your business name may be your actual name, but you can still choose to trade under a different title called your “trading name” should you wish. You can then include this on things like invoices and letters. This also gives you the opportunity to create a logo that can help from a branding perspective.
There are only a few limits on the names you can use. You are not generally permitted to use “sensitive” words in your company name, for instance (Virgin was likely skirting this rule!); likewise, you can’t use existing trademarks or other registered business names. Finally, you can’t have “Ltd” or “LLC” in your company name unless that is an accurate description of your business structure! If you want to stick something professional sounding at the end of your name, then consider “Productions” or “Studios.”
If you want to make sure that no one else can use your trading name/logo, then you will need to secure a trademark, usually via the US Patent and Trademark Office ( www.uspto.gov ) or your country’s equivalent (it’s the Intellectual Property Office in the UK: IPO.gov.uk ). The first step is to make sure no one else has already trademarked the name (a good thing to check even if you don’t intend on paying for the rights). After that, you can expect to pay somewhere in the region of a few hundred dollars in order to secure the exclusive rights for ten years.
Tips for Easy Accounting
Keeping track of all your revenue and your expenses might seem like a huge challenge, but if you go about it logically, it really needn’t be that bad. Here are some tips that can help a great deal.
Use PayPal
Maybe you balked at the PayPal fees and decided it wasn’t for you. That’s fine. But if you do use PayPal or a similar service, then this can make your life a lot easier. You can quickly generate a spreadsheet of all your income over a set period, and if this includes the lion’s share of what you got paid, then that will make life very easy.
Better yet, why not make your business purchases using PayPal too? I conduct the vast majority of all my buying through PayPal, and that means I can calculate my income and expenses for an entire year in a few hours max. In fact, if I make a business purchase through my PayPal account, then only my net profit need ever be withdrawn into my bank balance.
Use Invoices/Keep a Spreadsheet
If you opt to go another route, then this is where writing those invoices will benefit you as much as the clients. Keep a folder on your computer (ideally backed up to the cloud) and put all your invoices in here. Now when it comes to calculating your tax, you can just open them all up, look at the amounts, and calculate their sum total.
You can do the exact same thing for your expenses: just put any invoices you get sent into a single folder, along with any e-mail receipts.
Better yet, keep track of these as you go by updating a spreadsheet—or use one of many accounting apps that will help you to do this more easily. If you’re a coder, why not make your own?
Go Paperless
There was a time that you had to keep a physical copy of every single monthly statement your bank sent you. That’s a lot of pointless paperwork and a big filing cabinet!
These days, online banking gives us the option to go paperless. That will make your life significantly easier, not to mention being far kinder to the planet. Likewise, you should also be able to get your energy company, landlord/mortgage company, and so forth to all send you bills via e-mail.
Banks are still going to send you pointless written correspondence (I’m offered a credit card about one a month) and this is incredibly frustrating. But hey, it is what it is until lawmakers sort them out.
You can go paperless yourself by scanning/photographing documents and receipts, and then shredding the originals. You’ll even find programs with optical character recognition (OCR) that attempt to sort these for you automatically, and there are plenty of useful apps for this (such as Expensify: www.expensify.com ). A shredder is a good investment for any business owner or freelancer, as it will also help you to keep your personal data safe.
Company Account
Another useful tip is to set up a company account. This means opening up a separate bank account into which all income will be paid and from which all expenses will be taken. This not only helps to avoid confusion between personal and business costs, but it also means that your bank statement will pretty much provide all the information you could need for your tax returns or even an auditor.
While your business might not be a separate legal entity if you are a sole proprietor, most banks will still let you set up a business account if you like. But to be honest, it doesn’t even need to be a business account! As long as you have a separate bank account that is dedicated to work-related transactions, then you’re good to go.
Preparing for Pay Day
Another very important bit of planning you’ll need to do if you’re self-employed is to prepare for those tax payments.
The best rule is simply to take a third of whatever you earn and to stick it into a separate savings account. Once you’ve paid your tax, you can put anything left over into a savings account. This way, you’ll be able to keep things nice and simple, while also earning interest on your turnover throughout the year (another nice little bonus for the self-employed!).
Finding out precisely how much you earn by filing your return as soon as possible (at the end of the tax year) is generally a good idea. This way, you can prepare for the exact figure you need to save for and avoid any unpleasant surprises. If you can calculate the income for the previous year before your first quarterly payment is due, then you can also spread the amount due more equally across the year, rather than making up the difference with huge balancing payments.2
And if you should get caught short? Then you have options: you could take out a loan (such as a PayPal loan, which we will discuss in Chapter 10), you could ask for an advance from a client, or you could just work a few Saturdays. That’s where the flexibility of working in the gig economy can come in handy again.
Just don’t bury your head in the sand and hope that this is all going to go away. Checking your accounts on at least a semi-regular basis is a very good idea and can prevent potentially devastating surprises and mistakes. Like so many things, it’s not stressful or complicated as long as you are proactive!
Should You Use an Accountant?
I did warn you going in that this wasn’t going to be a fun chapter, and after all of the excitement and promise of the first half of this book, you might have found this to be a rather sour-tasting reality sandwich.
But while it sounds pretty daunting and you might currently be covered in a thin layer of cold sweat, the truth is that it isn’t half as bad as it sounds. I’ve included a lot of broad detail here in the interests of being comprehensive, but I’ve given you an idea of what you need to look into further to determine what does and doesn’t apply to you.
And you know what? Seventy-five percent of what we’ve covered may well fall into that latter category. Chances are that if you’re entering the gig economy as a freelancer, then you are simply providing a service as a sole proprietor, with very minimal overheads.
And if you’re willing to pay some small fees to use PayPal, or if you set up a business account with your bank, then accounting is pretty easy too. At the end of the tax year, all you need to do, then, is to get your total revenue, subtract your expenses (which is probably a few pieces of software, a proportion of your bills, and a laptop), and then pay the amount that is automatically generated online. It’s really that easy.
In other words: no, you don’t necessarily need an accountant (you could also consider looking into tax preparation software).
An accountant can save you a big headache by handling all your reporting and taxes for you. And in theory they should “pay for themselves” by saving you more money on expenses than they charge (they might set you back several hundred dollars depending on the individual service). The other good news is that you may be able to write off those expenses too!
One of the biggest benefits of going through an accountant is that it gives you some authority and some sense of security. Should you ever be audited, then you can just direct the auditor to your accountant. If you ever need to take out a loan, then having a tax return signed by an accountant can help you to gain the trust of the lenders, and so forth.
And sometimes an accountant will be necessary. For a sole proprietor in the UK, filing a tax return is pretty simple. But if you’re setting up a limited liability company that needs to pay sales tax in the United States, then you might be looking at a whole lot more paperwork. In that case, an accountant might absolutely be necessary—and certainly a big weight off your shoulders.
But then again, you might find the process of using an accountant is stressful in itself. If you don’t have a lot of expenses, then it might not ultimately prove to be worth your while. This is likely to come down to your personal preferences: there is no right or wrong answer here.3 My advice is to have a stab at filing a return yourself, and then to involve an accountant if necessary. Note that you should register your business as soon as possible when you start selling your services—even if you aren’t earning enough to be charged tax. This will also give you a good opportunity to see the websites and forms you’ll be using when you do file your returns.
A quick Google search for “Register a Business” or “Register as a Sole Proprietor” should get you started. Or you can use the resources such as the Small Business Administration website that I provided earlier. Look for the official government page. Ignore third parties that offer to get you up and running for a hefty fee. Those guys you definitely do not need.
The Financial Trials of Self-Employment
Whatever type of business you choose, you will find there are one or two things that become a little more difficult for the self-employed financially and legally. We’ve looked at a lot of positives so far, and so it’s only fair that we take a look at the downsides as they relate to your accounting, financing, and more.
Pensions
One downside of being self-employed is that you won’t be getting a pension plan from your employer. Instead, you’re going to need to sort this out yourself with a private pension. There are good options out there, just don’t forget about it until it’s too late!
Sick Pay
Another challenge you’ll face as someone who is self-employed is the lack of sick pay and health insurance. If you are ill and you can’t work, then you don’t get paid! And paying for your own health insurance in the US can get very expensive.
This can obviously add insult to injury, and it means that you might be in trouble if you have a long-term chronic illness.
There are a few ways around this. One is to set up some form of passive income to cover these additional expenses and unpredictable situations, which we will look at in the next chapter. Another is to factor a realistic number of “sick days” into your budget (which we’ll also look at in the next chapter).
If you have an ongoing medical condition, research what benefits are available in your area if any. You may find that you are eligible for certain government assistance depending on your circumstances.
Another good idea is to look into disability insurance that will pay out should you find yourself unable to work for an extended period of time. Shop around for health insurance and factor it into the price that you charge. Remember that this is what your employers would be doing were you to work a regular job. Only they also factor in costs such as the cost of renting an office, and covering maternity leave. You can charge less for your services than a big employer and still keep enough left over for health insurance. It just stings when you see so much of your hard earned cash disappearing before you’ve even had a chance to spend any of it!
Leave/Vacation
Yep, you guessed it: there is also no annual leave or holiday pay. If you want to take a week of holiday, then that’s coming out of your salary, bub! Likewise, depending on where you’re located in the world, you might also find there is no paternity/maternity pay offered by the state.
Remember: we’re saving money in many other ways by paying less tax (by being able to write off expenses) and by removing the need for a commute. This is simply something to keep in mind when budgeting.
Loans/Lease/Finance
One last problem you may run into as a member of the gig economy is that no one quite knows what to do with you. That is to say, that as someone who is self-employed, you might struggle when dealing with more “traditional” financial institutions. Getting a loan can be tricky, as can getting rented accommodation. The problem is that these organizations want proof that you’re always going to be able to pay the bills/loan repayments. When you’re self-employed, there are no such assurances (at least from their perspective).
The best thing you can do? Keep your affairs in good order. Make sure that you aren’t trying to claim back too much, avoid taking on unnecessary debt (consider a PayPal loan, discussed in Chapter 10), definitely make sure to keep your credit history in good repair, and try to demonstrate that your income is increasing year-on-year rather than going the other way. While you can’t provide pay slips, you can provide your tax returns, letters from accountants, and potentially letters from your long-term clients who can provide assurance that they will be using your services for a while.
As more and more people enter the gig economy, this will become less of a challenge. But for now, be prepared to fight a little with those that you need to borrow from!
Chapter Summary
This has been a painful chapter, no doubt. But you should feel proud of yourself: we’ve gone over all of the most potentially officious aspects of being self-employed that are necessary to create a business that is run the way it should be. Once you’ve handled the basics, then you can officially say that you are self-employed/a business owner. Exciting stuff!
What’s more is that this is all going to lead to even more exciting opportunities and possibilities. While budgeting and looking at expenses might seem pretty dry, you’re going to learn in the next chapter that this really isn’t the case. In fact, you’re going to learn how through understanding the numbers, you can potentially create the lifestyle you’ve always wanted.