Creating a budget as a freelancer shouldn’t be any harder than it is for any other small business. And yet, the rollercoaster ride of finding and keeping clients, collecting invoices, marketing your business and juggling all of this yourself can create major budgeting headaches. Income predictability is a challenge unique to freelancers, according to a recent survey by Upwork and Freelancers Union. Fortunately, there are many simple steps you can take better learn how to budget as a freelancer.
Step 1: Keep Business and Personal Finances Separate
Even if you used personal assets to start your freelance business, it’s important to create a clear boundary between your personal and business finances to avoid legal and tax issues down the road. The IRS makes very clear distinctions on whether your business is a for-profit business or a nonprofit hobby. Keeping your personal finances separate shows your business activities are truly intended to make a profit.
Set up a separate bank account for your freelance business and choose a user-friendly bookkeeping system to track your business income and expenses. Make it easier by selecting accounting software that’s compatible with your bank so you can sync the information and aren’t wasting time re-entering data over and over.
Do you want your small business finances to be available from wherever you are? If so, choose a cloud-based accounting program. Sticking to a business budget is easier when you can get real-time updates about receivables and payables. Choose an accounting system that has invoicing capabilities and easy-to-create reports for forecasting and budgeting. If you aren’t sure which accounting system is best for your freelance business, ask your accountant for recommendations.
As a freelancer, you can write off your business expenses on your taxes. The IRS website has hundreds of resources explaining what financial records you should keep, how long you should keep them, what tax forms you need to file, and much more. Use them to guide you through the many tax and reporting deadlines a small business is required to meet. Also, if you plan on submitting quarterly taxes, having a business bank account enables you to automate those payments.
Step 2: Budget for Your Form of Business
Your business structure determines your taxes. Some forms of business also have associated fees that you’ll need to budget for.
Here’s an overview.
- Sole Proprietorships: A sole proprietorship is the easiest structure to manage for a freelancer. You are the company, and you pay taxes on income from the business as part of your personal income tax. However, this structure has the most legal liability.
- Limited Liability Company (LLC): Many freelancers structure their businesses as LLCs to provide protection from legal liability. An LLC has some characteristics of a corporation and some of a sole proprietorship. It protects you from personal liability in case of judgment or debt. An LLC can also choose how it wants to be taxed—as a sole proprietorship, S Corp or C Corp. Profits and losses are reported on the owner’s individual tax return. Each state charges a filing fee for registering an LLC in that state; filing fees vary considerably from state to state. If you request a certified copy of your Articles of Incorporation, which you may need for tax purposes, there is a fee. Some states also charge LLCs a yearly license fee or franchise tax; this also varies from state to state.
- S Corps and C Corps: Because a C Corp is the costliest and most difficult type of business to form in terms of regulations and paperwork, the structure is not popular with freelancers. However, if you expect to make more money than you would have made at an equivalent full-time job as an employee, an S Corp allows you to split your profits between your employee wage and distributions of profits from your business. Talk to your accountant to see if this is advantageous for you. There are four types of fees for incorporating: the articles of incorporation filing fee; a first-year franchise tax prepayment; fees for various government filings; and attorney fees.
Step 3: Know What You Can Deduct and What You Can’t
Being a freelancer allows you to claim most of the same deductions as any business. The IRS considers the expenses of running your business deductible as long as the expense is both “ordinary and necessary.” An ordinary expense must be common and accepted in your field of business. A necessary expense must be helpful and appropriate for your business.
Here are the most common tax deductions you can take as a freelancer:
- Startup expenses: If you started your business in the calendar year you’re filing taxes for, you can deduct the expenses related to startup, such as research, marketing, equipment purchases, etc.
- Home-based business expenses: To take the home office deduction, you must meet two general rules: the portion of your home must be set aside for the exclusive use of running your business and it must be your principal place of business.
- Self-Employment health insurance tax deduction: Self-employed people can reduce their adjusted gross income by the amount they pay in health insurance premiums during a given year.
- Transportation: You can deduct the costs associated with transportation to and from meeting with clients, running errands for your business such as getting supplies or visiting warehouses, attending seminars and meetings and more. It’s important to keep careful records and logs of miles, repairs and maintenance.
- Travel: Travel expenses associated with the running, marketing and sales of your business are deductible, including plane and train fare, car rental, hotel, tips, and meals, dry cleaning and phone bills during trips.
- Entertainment and gifts for clients and potential clients: To claim this expense, you must be able to prove the entertainment cost was directly attributable to the expectation of a business benefit. Gift deductions cannot exceed $25.
- Charitable contributions: Most contributions are considered business expenses, so check with your tax expert on how to claim these contributions on your taxes.
- Education: As a freelancer, you can deduct expenses for qualifying work-related education directly from your self-employment income.
Step 4: Get Creative With Saving and Spending
If you’re just starting your freelance business, there are plenty of ways to save on startup costs, including working from home, buying refurbished equipment and more. Here are a few ideas:
- Did you know being green can save your business money? Changing to energy-saving light bulbs, unplugging equipment not in use, and limiting printing to only the essentials can really cut down on your energy bills. Check with your utility providers to schedule an energy audit for more cost-saving advice.
- Using business credit cards that offer rewards is smart if the rewards are beneficial to your business. Points can be used for business travel, supplies, client gifts and more.
- Study your finances for hidden expenses. Is there a recurring magazine or newsletter subscription you no longer need? Can you switch to a less expensive mobile phone plan, or find business vendors to provide products and services at a lower price? If you’re overspending on office supplies, buy in bulk or set up a “Subscribe and Save” account on Amazon to cut costs.
- Bartering is still taxable in the eyes of the IRS, but you will save cash by trading services or products with another business. You can set up your own barter agreement, or look for a local barter exchange or online barter service.
Step 5: Use Budgeting Apps
If you need more help with how to budget as a freelancer, check out the following top-rated budgeting apps. All have mobile versions so you can manage your budget on your smartphone or tablet.
- QuickBooks: You may already use QuickBooks for your personal finances, but if you don’t, check out the different options QB offers from the Sole Proprietor version to the LLC. Also from Intuit, check out Mint, a mobile budgeting app.
- FreshBooks: Keep track of billing time, create and manage invoices, and store it all in the cloud with FreshBooks.
- Penny: Penny is an AI chatbot. Give Penny access to all your accounts and she’ll text you updates on what you’ve spent, what bills are coming up, if any subscriptions have raised their rates, and more.
Like all aspects of entrepreneurship, figuring out how to budget as a freelancer will get easier as you become more confident and your business grows. Starting off on the right foot with good budgeting skills now will help put you on the road to success.