Published on 19 December 2012
On the up side, freelancing liberates you to work your own schedule, choose your own clients, avoid a long commute and be your own boss. On the down side, the more successful you are as a self-employed freelancer, the greater the risk of attracting an audit from the government. Though it may seem tedious, devoting a small amount of time to organizing an effective accounting system will keep your freelance business in order and minimize stress at tax time. Here is a five-step crash course in accounting for freelancers:
Step one: know how much money you earn, how much you spend, and how much you owe in your freelancing business. In accounting vernacular, these items are known as credits, debits and liabilities respectively. As a freelancer, you essentially function as your own CFO, so you need a bird's-eye view of your own financials at all times. To simplify this step, connect your bank account or credit card to an accounting app such as Wave, which will automatically categorize your income, expense and debt transactions for you.
Open a bank account and get a credit card for your freelance business, and use them only for your freelance business. This step cannot be overemphasized. Resist the temptation to charge a business expense on your personal credit card, and don't use your freelance business account to cover a personal expense. Pay yourself a reasonable amount as a weekly, bi-weekly or semi-monthly transfer from your business account - same as you would if you were receiving income from an employer. Mixing business and personal expenses means you're never exactly sure how much money you are earning and spending as a freelancer, which in turn complicates your accounting unnecessarily.
Freelancer lingo often includes the infamous line "I can write this off". Step three in our crash course in accounting for freelancers: Make sure you actually can write it off. Freelancers often get very creative about business expenses; however, according to the IRS, business expenses need to be "both ordinary and necessary". For instance, as a freelancer, a legitimate business expense would be a portion of your mortgage or rent if you work from home. Also, understand the difference between an expense and an asset. For example, early on you will likely incur several large equipment expenses for your freelancing business. Not to worry! These are actually assets - the technical term is fixed, or capital assets - and the value of these will be written off over the useful life of an item.
Develop a simple system for capturing and categorizing your business expense receipts the moment you create them. Stuffing uncategorized receipts into envelopes, file folders, shoeboxes or desk drawers is the kiss of death for your accounting - at tax time you will spend hours going through a year's worth of paper, and much of it you will have trouble remembering. One option is to take a photo of your receipt and save it to a DropBox folder to share with your accountant later. Another option is to use receipt-scanning software from a company like Shoeboxed to take care of this step for you.
Finally, hire an accountant you can trust to work with you quarterly, or once a year at tax time. If you opt for accounting software to run your freelancing business, many programs allow you to invite your accountant to work on your books remotely. The benefit of professional help for freelancers is twofold: An accountant knows what you can expense and what you can't, which removes the guesswork from Step Three. And an accountant will flag discrepancies in your accounting and correct them before the tax authorities do, which can save you hundreds or even thousands of dollars in penalties.
Wave is an online accounting software designed to help you be your own boss. Small business owners from all over the world trust Wave to help them with their accounting, invoicing, payroll and payment needs. Launched in 2010, Wave has already welcomed nearly a half a million users.