How to do your accounts as a freelancer

When you’re a freelancer, managing your accounts can feel both empowering and unnerving. On one hand, it feels empowering because you get to exhibit more flexibility over your finances.

However, on the other hand, understanding the gravity of making your accounts accurate and complying with tax regulations could have you feeling like a weight has been placed on your shoulders.

To help you, here’s a detailed guide to help you get through the accounting process as a freelance worker with confidence.

Understand your financial obligations

As a freelancer, you’re obligated to pay income tax, self-employment tax, and state and local taxes. 

Income tax is a portion of your earnings that gets paid to the federal government. Depending on the region you reside in, you might have to pay income tax to the state and local governments.

Next, you’ll have to pay self-employment tax, which secures Social Security and Medicare. In a typical organization, the employer and employee split the Social Security and Medicare payments. However, since you’re practically the employer and employee, you need to take care of this cost. Self-employment tax is 15.3% of your net earnings.

Finally, you’re subject to state and local taxes, which vary depending on where you stay.

You need to track your deductible expenses to decrease taxable income, comply with tax laws, and boost your financial management capabilities. When you deduct your business expenses, your taxable income is reduced. For instance, if you earn $100,000 in a financial year and deduct $40,000 as business expenses, you pay tax on the remaining $60,000.

Tax agencies mandate businesses to report their income and expenses accurately. By recording your deductible expenses, you get to stay on the right side of the law. Also, if you’re being audited, keeping records like receipts and invoices can prove the legitimacy of your deductions.

Some typical deductible expenses for freelancers include software subscriptions, office supplies, advertising costs, and travel expenses. You can leverage the best personal accounting software outlined by Rhiannon Stone because they ease up the process by automatically categorizing expenses into categories and calculating self-employment tax based on your income.

Understanding how to manage invoices for your clients is crucial. An invoice shows that you’re a professional freelancer. When creating an invoice, you must ensure it contains your business name and contact information, the client’s name and contact information, invoice number, date of issue and due date, and the description of the services rendered.

Create a system

You need a system to split up your personal and business transactions. 

To start with, you need to set up a business bank account that’ll be used solely for your freelance transactions. You need to choose a bank that meets your business needs. To choose the right bank, you can review its fees to ensure that they’re low and the proximity of its branch locations to where you mostly work.

Opening a bank account requires personal identification, like a driver’s license or passport. The bank might request your business’s Employer Identification Number (EIN) or Social Security Number. Depending on the bank, you could also be asked to submit proof of business registration.

Once you’ve created the business bank account, you need to direct your clients to make payments into the account. No matter the circumstances, avoid asking your clients to pay into your personal account so that you can maintain a clear financial trail. Personal accounts are meant to pay household bills and facilitate entertainment activities like watching movies, gaming at real money online casinos, or going to concerts. 

Every bit of cash that needs to be spent on the job has to come from the business account. During the month when you need to pay yourself, you can then transfer the funds from your business bank account to your personal account. You can record this in your books as an owner’s draw.

You can get a business credit card. Business credit cards help further create a distinction between your business and personal accounts. You can use the credit card to clear your business expenses and pay it off from your business bank account. This way, you get to build your business credit.

You have to establish a routine for managing your freelance accounts to ensure that your finances remain organized. Some freelancers delay updating their accounts and then find themselves having to rush during tax season, leading to errors and penalties from tax agencies.

To create an efficient routine, you need to focus on recording expenses and income and reconciling bank statements.

At the end of each working day, you can record each expense and income in your accounting software. A good practice is to assign expenses to categories like software or travel. By the end of the month, you need to review the transactions to verify that they’re accurate. You can leverage mobile apps or receipt scanners to digitize physical receipts.

Next, you must ensure that the transactions in your accounting software match those in your bank statement at least once a month. Once you spot any discrepancies, you need to identify them and resolve them immediately.

To maintain your routine, you can set aside a specific time and date each month to work on your accounting tasks. You also need to create a checklist to make sure you complete all crucial assignments.

Taking these steps will help you manage your finances effectively as a freelancer, ensuring that you remain financially stable and comply with tax obligations.

Budget for taxes

In the United States, freelancers are obligated to pay estimated taxes every quarter. This prevents them from accumulating a large tax bill at the end of each year.

To estimate quarterly taxes, you can reflect on the new clients you’re working for or new projects you’re handling that will impact your annual income. If you’ve been working as a freelancer for at least a year, you can check the previous year’s income to estimate how much you’ll earn.

Next, you have to estimate your annual expenses by evaluating your costs for the previous year and considering factors that can lead to new costs. Subtract the estimated expense from your estimated income to get your net or taxable income.

First, calculate the federal, state, and local taxes to your taxable income. Second, calculate the self-employment tax rate of 15.3% on the taxable income. Divide the result by 4 to get your quarterly payment. To help estimate your income, deductions, and credits, you can use the IRS Form 1040-ES.

To prevent your business from struggling when your tax payments are due, you need to save some of your income monthly. You can create a separate savings account for your tax payments to avoid your finances from getting muddled up.

Some bank accounts facilitate automatic transfers between accounts. You can leverage this automation to prevent yourself from skipping a month.

As a rule of thumb, you need to save 30% of your gross income to settle federal, state, and self-employment taxes. You need to monitor your tax savings balance to make certain that it is the same as your tax liabilities.

Know and comply with your financial obligations

Handling your accounts as a freelancer can prove to be intimidating, especially if you don’t understand how the tax system works. You need to understand your financial obligations, create a system, and budget for taxes to ensure that you remain compliant with tax laws.