Bookkeeping for Independent Contractors: Everything You Need to Know
When someone employs you as an “independent contractor,” what precisely does that mean? Is that the same as working for yourself? What is the difference if not? Here is our in-depth guide on bookkeeping for independent contractors, including information on what they are, how to become one, what makes them successful, how they file taxes, and software that can be used for accounting for independent contractors.
What are Independent Contractors?
Anyone who works on a contract basis to finish a specific project or task is an independent contractor. You are considered a business by the law because you are an independent contractor. You will have to pay taxes and maintain your bookkeeping as a business. You probably chose to work independently because you wanted to escape the routine weekday or because you possessed a specialty that companies sought after. But as an independent contractor, you might not have understood how crucial it is to make sure you stay on top of your bookkeeping and accounting.
Employees are people who perform standard 9 to 5 jobs for a business. A portion of the employee’s salary will be withheld by the employer and reported. Each check has a portion withheld to pay for unemployed benefits, social security, Medicare, and tax obligations. All employee taxable income is documented on a W-2 form and reported to the IRS each year.
This applies to every employee of an organization. It is different, though, when a business employs an independent contractor. Contractors are responsible for paying their taxes on time and are not dependent on businesses to deduct income tax on their behalf.
Even though it may seem scary, with the correct assistance, you can manage your taxes and bookkeeping like a pro!
What Sets Independent Contractors Apart from Employees
In essence, you are not an employee of the company you are working for if you are an independent contractor. Regular pay, withholding of taxes from that pay, and the creation of an employee’s schedule by their employer are all benefits of employment.
In contrast to employees, independent contractors work independently. Work when it suits you, file your own taxes, and be paid for the tasks you work on.
You have a lot more freedom as an independent contractor than most other types of workers have. You are your own boss, responsible for setting your own schedule and paying your own taxes.
The downside is that your employers won’t contribute to your 401(k), workers’ compensation, bonuses, unemployment taxes, payroll taxes, or health insurance (K). The Occupational Safety & Health Act (OSHA), the Fair Labor Standards Act (FLSA), and Title VII of the Civil Rights Act are just a few of the employee benefits you would forego.
How to become an independent contractor?
A solitary proprietorship and being an independent contractor share some similarities. You only need to get to work. Without you realizing it, you could already be an independent contractor right now!
Before you begin working for a client, you will typically be required to sign a written contract (thus the term “contractor”).
The basic contract is a fantastic place to start if you’re looking for a solid template contract for an independent contractor arrangement.
What Makes Independent Contractors Successful?
Choose an accounting strategy
When submitting their first tax returns as a firm, independent contractors have a choice between two basic accounting procedures.
The simplest type of tax return is cash basis. It keeps track of your earnings as they are received and your outgoing costs as they are settled.
When using an accrual basis, your costs and cash will be recorded as incurred rather than as received. Since you must account for the money when the work is complete, this can be more complicated. It is known to provide a firm with additional information about its prospects for the future, though.
When determining which accounting approach will be most beneficial for your independent contracting business, it is recommended practice to consult a CPA.
How to File Your Taxes as a Self-Employed Person
The IRS requires independent contractors to pay self-employment taxes. Currently, that means you will pay 15.3 percent for social security, 12.4 percent for Medicare, and 2.9 percent for both. You will make payment by submitting a Schedule SE.
One of the schedules on your Form 1040, Individual Income Tax Return, will be a Schedule SE. You should figure up your total self-employment income and loss using the Schedule C portion of Form 1040’s line 31 before completing your SE.
A customer is required to file and send you a copy of Form 1099-MISC whenever you accomplish work for them that costs more than $600. This is an informational form that must be submitted to the IRS in order to report non-salary income. You should contact your client again if they fail to provide you a Form 1099-MISC.
It is significant to emphasize that independent contractors must set aside funds to cover their own contributions to social security, Medicare, and self-employment taxes.
Never let your bookkeeping and accounting fall behind
All independent contractors need to stay on top of their company’s accounting and bookkeeping procedures.
You may create financial reports that will enable you to plan and make informed decisions for the future with the aid of proper bookkeeping.
Bookkeeping for independent contractors, keeping your books organized, can make sure that all invoices for your company are sent out on time, that your accounts receivable are being paid, and that you pay your credit card bills.
As an independent contractor, keeping track of the money you receive and withdraw from your account is crucial.
No matter how big or small your business is, you must keep track of every expense. If there is an audit, you won’t be able to support your expenditures if you don’t have the necessary paperwork.
An independent contractor can keep track of their earnings and outlays in a variety of ways. It’s possible that your friend’s bookkeeping is done differently from yours. The most crucial thing is to establish and maintain a financial tracking system that works for you.
Some items that you could track are:
- office lease
- phone, printer, or computer purchase invoices
- the number of hours a project was worked on
- every task you accomplish for clients
- hourly rate for each client
- operating expenses for your business
- paid invoices to you
- payments from a bank
- customer payments
- traveling costs
- phone and internet bills
- career-focused seminars, lectures, and books.
- office equipment
- costs of web hosting and design
- accounting programs
Never combine personal and business expenses
You should open a separate bank account for your independent contractor firm. You can more easily do this by separating your money situation from your business affairs. It is advantageous to have everything separated in the event of an audit, especially if you consider yourself to be a business. If your claims are contested, you can support your records with various accounts.
Establish a Business
You are still eligible for the payment if you work as a hired contractor. However, generating your Employer ID Number is very advantageous. Having a company entity comes with numerous tax advantages and savings.
Tax Estimations: Pay Now to Save!
You run the danger of an IRS audit if you fail to file your profit and cost statements. During audits, a contractor’s wages are questioned.
Paying taxes and having precise estimates of your upcoming tax obligations are quite beneficial. Putting your estimated tax payments in each month or every three months will help you avoid a tax bill that isn’t expected.
Independent contractors should typically set aside between 30 and 40% of their income for tax purposes.
Get Yourself Ready for the Future
No matter how successful you currently feel as you are an independent contractor, it would be beneficial if you looked ahead. In the modern marketplace, things can change very quickly.
The same month this year may not be at all like this month. By examining your past and present, financial reports can help your organization get ready for the future and get you ready to make decisions.
Setting yourself up for a more promising future will involve saving money and paying anticipated taxes in advance.
Accounting and bookkeeping software
Let’s face it: Unless you work as a freelance bookkeeper or accountant, they are probably not your strongest suit.
Even those with the worst accounting skills can become competent bookkeepers with the aid of accounting software!
The most important advantages of accounting for independent contractors are that it makes it easier for you to get paid, provides data for correct financial records, aids in tax estimation, and keeps you from becoming overwhelmed in the event of an audit.
For any contractor, being paid for your services is essential. The simplicity of invoicing accounting software will make this easy to accomplish. You may invoice your customers and keep track of overdue invoices with accounting software.
Above all, establishing accuracy and order in your organization is the biggest advantage of using accounting software. The first step for many brand-new small business owners is to enter all of their bookkeeping data onto an Excel spreadsheet. Excel data entry requires manual effort, which increases the likelihood of human error. To manage your books, the software will automatically import your invoices, payments received, payments returned, and expenses.
Be Honest About Your Earnings and Expenses
You risk receiving payment directly to your personal account if you are not careful to keep your personal and company bank accounts separate.
Everything can be too alluring to just brush it under the rug to get paid to your own account. Even if there are some immediate advantages, like avoiding having to pay taxes on that money, getting discovered during an audit is not worthwhile.
It will also be easier for you to see your income and expenses as an independent contractor if your bookkeeping is transparent. You can decide wisely on how to expand your business thanks to the transparency of the financials.
Sync up your bank transactions
Reconciling bank accounts is something independent contractors should consider. You can make sure that every transaction matches your accounts by practicing reconciliation. It is an excellent method to get ready for tax season.
It can be a huge chore if you try to reconcile your books on your own. You may easily balance your bank accounts by accounting for independent contractors with software like MyCountSolutions, Zero, Wave, or Freshbooks.
DIY Bookkeeping & Accounting or Professional Services?
Many new independent contractors will begin by handling their own bookkeeping. Being accountable for your books might help you save money while beginning your firm because cash flow can be limited in the early stages.
You’ll realize how helpful it would be as your company expands if you could use the time you currently spend on independent contractor bookkeeping to do tasks that fall within your area of expertise, find new clients, and more. As an independent contractor, hiring a professional to handle your bookkeeping needs will give you the freedom you need to expand your company.
It will be advantageous for the majority of independent contractors to hire a CPA at the very least to assist throughout tax season. Your balance sheet, income statement, statement of cash flow and other financial reports can be created and understood by a competent accountant, who can also assist you with tax season. It provides you with a clearer picture of the state and direction of your company at the moment.
You might ask yourself if you can afford to hire a professional before making your decision. However, the question you should be considering is whether you can afford to forgo seeking professional assistance with such crucial information.
What is MyCountSolutions?
We are a live human-powered online bookkeeping service. With MyCountSolutions, you get a committed bookkeeper who is assisted by a group of knowledgeable small company specialists. We’re here to eliminate uncertainty from running your own business permanently. Every month, your bookkeeping team categorizes transactions, imports bank statements, and creates financial statements, as well as relieves you from the stress of taxes. You can sign up for a month of free bookkeeping to get a feel of the best accounting and bookkeeping for independent contractors.
Although independent contractors can resemble ordinary employees, they are actually separate legal entities from the companies for which they work.
The simplicity of having taxes deducted from each paycheck by an employer does not apply to independent contractors. Instead, their tiny firms are independent contractors. They must pay close attention to their bookkeeping and books.
Any independent contractor’s understanding of their business will improve with a clear understanding of their financial situation. They will be better equipped to accurately pay their taxes to the IRS. Understanding their costs can help them choose how much to charge for their services.