How to Get Started With Self-Employment and Manage Your Finances

Becoming self-employed offers flexibility and control but also comes with financial responsibilities. Without an employer managing taxes and benefits, you must handle these aspects yourself to ensure stability and compliance.

Managing finances properly from the start prevents costly mistakes and makes tax season less stressful. Structuring your business, tracking income and expenses, and planning for taxes will keep everything organized.

Selecting a Business Structure

Your choice of business structure impacts taxes, liability, and administrative complexity. The simplest option is a sole proprietorship, where business income is reported on your personal tax return, but you are personally responsible for debts and legal issues.

A limited liability company (LLC) provides personal asset protection while maintaining tax flexibility. By default, a single-member LLC is taxed like a sole proprietorship, but electing S corporation status can reduce self-employment taxes by allowing part of the income to be taken as distributions rather than salary.

For those planning to scale, an S corporation or C corporation may be beneficial. An S corporation avoids double taxation by passing income to shareholders but has ownership restrictions and requires more formalities. A C corporation is taxed separately from its owners at a 21% federal rate, with dividends taxed again at the individual level, making it useful for reinvesting profits rather than distributing them.

Registering with Authorities

Once you’ve chosen a structure, ensure your business is legally recognized. Obtaining an Employer Identification Number (EIN) from the IRS is often necessary, even for sole proprietors, as it helps separate business and personal finances and is required for business bank accounts and tax filings. The IRS provides EINs for free through an online application.

State and local regulations may require business registration. Many states mandate filing a Doing Business As (DBA) name if operating under a different name. Certain industries require licenses or permits—freelance accountants may need state certification, while home-based businesses might need zoning approvals. Checking with your state’s business office ensures compliance.

Sales tax obligations depend on your work and client locations. If selling physical or digital goods, you may need to collect and remit sales tax. Some states require sellers to register for a sales tax permit, while services are often exempt. Understanding nexus laws, which determine tax obligations based on economic activity within a state, helps avoid penalties.

Opening a Separate Business Bank Account

Separating business and personal finances simplifies bookkeeping, tax reporting, and legal protections. A dedicated business account prevents commingling of funds, which is crucial for maintaining liability protections in structures like LLCs. If personal and business transactions mix, courts may disregard the corporate veil, exposing personal assets to business liabilities.

Banks offer business checking accounts with varying fee structures, transaction limits, and balance requirements. Some waive fees if a certain balance is maintained, while others charge per transaction beyond a threshold. Online banks like Mercury and Relay cater to small businesses with no monthly fees and accounting software integration, while traditional banks such as Chase and Bank of America provide in-person services and business credit options.

Business debit and credit cards further separate expenses while building a credit history. A strong credit profile improves access to financing, such as business loans or lines of credit. Using a business credit card responsibly—keeping utilization low and paying balances on time—can lead to higher credit limits and better loan terms.

Recording Expenses and Income

Tracking financial transactions ensures tax compliance, supports budgeting, and provides insight into business performance. Accounting software like QuickBooks, Xero, or Wave automates categorization and generates financial statements. Consistently recording transactions minimizes errors and simplifies audits.

Deductible expenses reduce taxable income but must meet IRS guidelines as “ordinary and necessary” for business operations. Common deductions include office supplies, software subscriptions, advertising costs, and home office expenses. The home office deduction can be calculated using either the simplified method ($5 per square foot, up to 300 square feet) or the actual expense method, which prorates costs like rent and utilities. Misclassifying personal expenses as business-related can trigger penalties, so maintaining clear documentation is necessary.

Depreciable assets, such as computers and machinery, must be deducted over time according to IRS guidelines. Section 179 allows immediate expensing of qualifying assets up to $1,220,000 in 2024, subject to a phase-out threshold of $3,050,000. Understanding depreciation rules prevents misreporting and optimizes tax benefits.

Invoicing and Payment Collection

Generating invoices correctly and ensuring timely payments maintain steady cash flow. Each invoice should include the business name, contact information, invoice number, date, payment terms, and a breakdown of services or products provided. Standard payment terms like “Net 30” or “Due Upon Receipt” set clear expectations. Offering early payment discounts (e.g., 2% off if paid within 10 days) can encourage faster settlements. Invoicing software such as FreshBooks or Zoho Invoice automates reminders and integrates with payment processors, reducing administrative workload.

Late payments disrupt financial planning, so a structured follow-up process is helpful. Sending reminders before and after the due date maintains communication. Charging late fees, typically 1-1.5% of the outstanding balance per month, can deter delays. For persistent non-payers, escalating to a collection agency or pursuing legal action through small claims court may be necessary, though this should be a last resort due to associated costs and time investment.

Handling Tax Requirements

Self-employed individuals must handle their own tax obligations, which differ from traditional employment where taxes are withheld automatically. Understanding how to calculate and remit taxes ensures compliance and avoids penalties.

Self-Employment Tax

Without an employer covering Social Security and Medicare taxes, self-employed individuals pay the full 15.3% self-employment tax. This includes 12.4% for Social Security on earnings up to $168,600 in 2024 and 2.9% for Medicare, with an additional 0.9% Medicare surtax on income exceeding $200,000 for single filers or $250,000 for married couples filing jointly. The IRS allows deducting half of this tax as an adjustment to income, reducing taxable earnings.

Quarterly Estimated Tax

Since taxes aren’t withheld from earnings, self-employed individuals must make estimated tax payments four times a year. The IRS requires these payments if total tax liability exceeds $1,000 annually. Due dates fall on April 15, June 15, September 15, and January 15 of the following year. Underpayment can result in penalties based on the federal short-term interest rate plus 3%. To avoid this, taxpayers can use the “safe harbor” rule by paying either 90% of the current year’s tax liability or 100% of the prior year’s total tax, whichever is lower.

Year-End Filings

At year-end, self-employed individuals must file Schedule C (Profit or Loss from Business) with their Form 1040 to report income and deductions. Those who hire contractors and pay them $600 or more must issue Form 1099-NEC by January 31. Businesses with employees must file W-2s and remit payroll taxes. Keeping thorough records throughout the year simplifies tax preparation and minimizes audit risk.

Setting Aside Funds for Retirement

Without employer-sponsored retirement plans, self-employed individuals must proactively save for the future. Several tax-advantaged accounts offer benefits tailored to self-employed workers.

A SEP IRA allows contributions of up to 25% of net earnings, capped at $69,000 in 2024. A Solo 401(k) provides higher contribution limits, allowing both employee deferrals and employer contributions up to a total cap of $69,000 ($76,500 with catch-up contributions). A SIMPLE IRA has lower limits but is easier to administer. Roth IRAs provide tax-free withdrawals in retirement, making them a strategic supplement for those expecting higher future tax rates.