Financial Advice for the Self-Employedby Stephanie Lee /
Home-based business owner Stephanie Lee of Host Agency Reviews writes a monthly column on issues faced by travel agents who work from home.
If you recently switched from employee to independent contractor or self-employed business owner, as I did earlier this year, you already know it’s a rude awakening for your checkbook.
No doubt you expected to have to spend money to make money, so you budgeted for business cards, trainings, etc. But what you conveniently overlooked were important big ticket items – like taxes, health insurance and planning for your retirement.
With a New Year just around the corner, this is a great time to review the fundamentals so you can be sure to make 2013 the year you organize your business finances!
The grass is always greener . . .
When you first join the ranks of the self-employed, pretty quickly you start to realize a few things you may have overlooked in the past.
First thing noted, you didn’t appreciate your employer paying a portion of your taxes anywhere near enough. Now that you’re footing the bill, it seems quite generous of them.
Next thing that dawns on you, you need to kiss your managed health insurance and retirement plan goodbye. You’re on your own.
Next thing that dawns on you – the beauty of a regular paycheck.
Missing the magic
Even if your job didn’t have a cushy benefits package that you now lament, you can’t deny you miss the paycheck that used to arrive every two weeks. Like magic, it came – regardless of how much effort you put in, or didn’t put in, during the prior pay period.
But as self-employed people, by default we are paid erratically. Busy seasons have our eyes gleaming with delight as the “paychecks” roll in. On the flip side, just live with us during the slow season and you’ll know the meaning of austerity.
Maybe being an employee wasn’t so bad after all?
Nah, don’t be silly. You love this life!
The question is, how can you combat the challenges of no benefits and a fluctuating income?
The mirage of IC pay
First things first, adjust how you see the “pay checks” you earn when you’re self-employed.
As an employee, a $1,000 paycheck is pretty straight forward – it means that, after withholding and all the rest, you got to take home $1,000.
But for an independent contractor that $1,000 check means something else altogether – and it’s downright misleading. That’s because the amount you get to “take home” will be less than what you see. For one thing, you haven’t paid the Tax Man yet.
Paying the tax man
So I’m going to be a fun-hater here. Every time you receive your check, go ahead and dock yourself 20% to 35% to cover your taxes. There. Now you’ve got a realistic view of your take home pay.
If your travel agency is in its first few years, estimating how much you’ll pay in taxes can be tricky. You don’t want to overpay and feel pinched in the short term, but nor do you want to underpay and have to scramble come tax time.
My best advice? Schedule an appointment with a tax professional who specializes in small businesses. They’ll help you get set up. By the way, keep track of what that appointment costs you, because it’s a tax-deductible expense.
Dealing with highs and lows
Beyond misleading paychecks that tease you with the promise of 20% to 35% more money than you really have, you’ll have to deal with the feast or famine pay cycle.
Busy season, you can’t believe your luck! Slow season, you long for a hefty check to come your way.
In the meantime, what do you do about paying for your health insurance and contributing to your 401k?
Previously, your employer took a certain dollar amount out of each check to pay for your health insurance and contribute to your 401k. Does that mean you now take the same dollar amount out of every check that comes in?
Nope. While it’d be no problem to do so when you receive large commission checks, it’s not quite as much fun when your commission checks are so small they don’t even cover your day-to-day bills.
We need to make things more predictable and manageable, and we do that through percentages, not hard numbers.
Case in point
Let’s say you expect to bring in $50,000 this year. The tax professional estimates you’ll owe $10,000 in taxes, your health insurance is $3,000 per year (and that’s a low estimate), and you ideally want to save $5,000 for retirement this year.
Total income: $50,000. Cost of taxes and benefits: $18,000.
In other words, 36% of your total income will go to taxes and benefits.
To break the feast or famine cycle, whenever a check comes in, immediately set aside 36% to pay for taxes and benefits.
Wait! This difference between actual pay and take home pay seems familiar doesn’t it? Yup. It’s pretty close to what you saw happen to the biweekly pay you thought you missed so much.
Former host agency director Stephanie Lee operates Host Agency Reviews, which features agent reviews of host agencies and tips for starting and growing a travel agency. Connect with Steph on Facebook, Twitter or Google+.