Becoming Your Own Boss (BYOB, 3.0)

In the first and second articles of this series (BYOB, 1.0 and 1.1) you learned some of the facts related to the current employment picture and examined some of the choices that were available to you. In the third, fourth, and fifth articles of this series (BYOB, 2.0, 2.1, and 2.2) you answered some key question to find if starting as an independent contractor was a good idea for you.

This set of articles (BYOB, 3.x) covers a number of topics that will make it more likely that you will succeed as an independent contractor. By now, you have arrived at one of two conclusions. Either you are curious about the concept of independent contracting, or you have already made a tentative decision to become an independent contractor and you want to know more of what is involved in the rest of the process.

Or you have answered the questions posed in the third, fourth, and fifth articles of this series (BYOB, 2.0, 2.1, and 2.2), evaluated the answers, and arrived at the decision that it would be appropriate and desirable for you to become an independent contractor - all after careful and objective analysis and with the full agreement of any family members involved.

In either case, read on. Now comes the start of the hard part. This set of articles will help you to make certain that you accomplish the steps necessary to prepare properly for the transition.

Overall Tax Implications

We place this part of our coverage of the preparation process first because it is important that you be knowledgeable on tax matters early in the process so you that can plan accordingly. This is not intended to in any way dissuade you from becoming an independent contractor. It is meant only to remind you that your overall tax planning and tax handling procedures are important to your success. The following paragraphs offer brief guidelines and suggestions as to sources of information. However, your best source of both tax information and tax planning help is your friendly accountant/tax specialist.

The booklet Tax Guide for Small Business, Internal Revenue Service Publication 334, offers a general description of the federal tax structure for small business.

As a business operator (dependent upon your business structure), you will probably be required to file quarterly estimated tax returns on IRS Form 1040-ES. This is explained in Tax Withholding and Estimated Tax, Internal Revenue Service Publication 505.

These and other IRS publications and forms are available free by calling 1-800-TAX-FORM (829-3676), or by checking online at the IRS Forms and Publications web site.

If you do not incorporate, each of your clients will be required to send you a Form 1099 in January. This form will show the amount paid to you in the previous year. If you incorporate, you will not receive such information. You or your accountant will derive it from your records.

If you do not incorporate, you will be required to pay self-employment tax, which is equivalent to both the employee and employer shares of the Federally Insured Contributions Act (FICA) tax. Regarding FICA, or Social Security, or whatever you may choose to call it, there is no free lunch. If you incorporate, you will be required to pay the employer share as the corporation, and then pay the employee share as an employee of the corporation. Again, there is no free lunch.

All of the above pertain to federal taxes. In addition, there are various state taxing agencies to which you must pay a share of your income. In many instances, state agencies are more aggressive in collecting taxes than is the IRS. Most will allow you an occasional mistake, but never give them the impression that you are attempting to wiggle out of paying what they consider to be your fair share. And bear in mind that what you consider to be your fair share and what they consider to be your fair share are often markedly different. In such cases, they will sometimes review their decisions, but, most often, their opinions carry much heavier weight than yours. Penalties are often truly onerous, and they do not hesitate to assess such penalties.

Timely, proper, and effective planning is the key to reduced tax problems. Again, your best source of information and help is a competent tax specialist.

Establishing You Contingency Fund

It is clear that, in preparing for business, understanding your tax obligations is one of the most important items, so it is placed first. However, virtually as important is the concept of a contingency fund, so this item is second.

Set up this fund so as to allow unrestricted access to enough money to support you (and your family if you have one) and your business (including your marketing efforts) for at least four and preferably six months. Dependent upon the demand for services in your area and upon your marketing effectiveness, it could well be that you will not require any extra funds at business start-up. If so, wonderful! It is more likely however, that you will expend at least some reserve funds because of a slack period at the beginning. If you expend some of this contingency fund, make certain that you replace the funds as soon as possible. You simply have no way of knowing when there might be a break between contracts or just how long that break might be.

Establish this fund as a personal account of some kind, or perhaps as several accounts. Do not transfer large sums into business accounts at the start of business. If you do so and, at some later date, use some of those funds for living expenses, the transfers will be considered as income and you will be forced to pay income and other taxes on the funds. It is much preferred to adopt a wait-and-see attitude. It is possible that no extra funds will ever be required for the business. If the business does require extra funds, wait until the requirement actually occurs, then transfer the minimum amount required as an investment in the business or as a loan to the business. In this way, your cash investment in the business and your income taxes will be as low as possible regarding contingencies. Again, your best source of information is your accountant/tax specialist.

The next article in this series (BYOB, 3.1) addresses the important topics of maintaining prior business and personal relationships, and establishing your office.

To read the rest of the series click here