In 2017, thousands of boomer employees will transition to self-employed work, finally pursuing their creative, back-burner passions full-time. Trouble is, they’re often not versed in how to handle their finances as entrepreneurs.
Many don’t know about the tax deductions and credits they’re now entitled to claim as self-employed people — ones they couldn’t take as employees. Some know they can take the write-offs, but aren’t sure how to document them for the Internal Revenue Service (IRS). So they don’t put these tax breaks on their tax returns, leaving thousands of dollars on the table.
This mistake also increases their chances of tanking their pursuit, because it becomes costlier than necessary.
Just ask Mark Samson, an Intel circuit designer for 20+ years who transitioned to owning a photography studio in Portland, Ore. “I felt like the whole support I had as an employee was just pulled out from under me. How did I figure out pricing, keep receipts, account for overhead, bring in clients, network? It was overwhelming,” says Samson.
Entrepreneurs like Samson who stick it out often make do by creating excel spreadsheets of their expenses and relying on their accountants for any possible deductions.
But even those who succeed in developing their craft can continue to struggle with making the business viable. Three years after opening his studio, Samson has built a reputation as an exceptional portrait photographer but berates himself for how poorly he keeps receipts and manages the finances. “I’m still eating into my savings from my first career. It’s just really hard to keep track of everything and still do what I love, which is take pictures," he says.
If you plan on transitioning to self-employment, here are four valuable accounting and tax tips to lower the financial stress of your second act:
1. Understand that there are two tax systems: One for employees and one for business owners
In the first one, your employer takes care of your tax withholding and you have no way to leverage the tax code to your advantage. In the second one, you can often deduct meals, travel, business use of a car and more. But the burden of proof is on you if you get audited. So you need to document everything in a very specific, IRS-compliant way.
Using easy-to-use accounting software can help you streamline your record-keeping and inform your accountant of the details he or she will need to help you save more in taxes each year. If you’re looking for invoicing software that can handle double-entry accounting, you could check out Billy (where I work). If you’d need features like payroll, Kashflow is a good option as well. If you’re more comfortable with accounting jargon, Xero has a full set-up with business features including inventory management.
2. Keep receipts and categorize them with appropriate accounting software
Just as Samson highlighted, receipt preservation can be the bane of many entrepreneurs’ existence. But with the right accounting software with a mobile app or browser extension, receipts are photographed, imported and categorized easily. This way, the business owner is not left with a box of miscellaneous receipts come tax time (the notorious “shoe-box client,” feared by accountants the world over).
3. Hand over full documentation to a business-savvy tax accountant
Given the right documents, an accountant who is well versed in the tax code for entrepreneurs can take full advantage of the deductions available to you (as long as you heed the preceding tips).
Many self-employed people unfortunately (for them) just dump everything on the lap of their accountant and miss out on important ways to claim deductions. For example, a photographer who took a trip to Hawaii could have written off the vacation by taking some pictures and visiting a few galleries with the intent to sell work. But how would the photographer’s accountant know unless he or she was trained to ask or the client kept good records?
Or maybe you use your home internet mostly for your business. Could that be deductible? An accountant experienced with freelancers can answer the question.
4. Learn to practice “the money habit”
Part of being IRS-compliant is “the money habit.” It’s the 15 minutes a week you spend documenting your business-related transactions. Don’t make the mistake of putting off “the numbers” for later. Later won’t happen.
Here’s an example of putting “the money habit” to work. If you take your spouse, a client and his wife to a meal to discuss business, you can deduct 50 percent of the cost of the meal, but you need a copy of your receipt and information about what the meal was about, who it was with, what was discussed, etc. Are you going to remember what you discussed over dinner six months ago? Doubtful. So start a weekly “money habit.”