How to Keep Track of Self-Employment Income

Self-employment income refers to earnings from a trade or business where an individual works for themselves. This includes income for sole proprietors, independent contractors, and partners. Proper tracking of this income and related expenses is important for understanding your financial standing and fulfilling tax obligations, including self-employment tax for Social Security and Medicare.

Understanding What to Track

Tracking both income and expenses is foundational for any self-employed individual. This allows for an accurate calculation of net profit or loss, which directly impacts your tax liability. The IRS mandates that self-employed individuals pay self-employment tax on net earnings exceeding $400 in a tax year. This tax covers Social Security and Medicare contributions.

Income tracking involves recording all payments received from clients, sales of goods, or fees for services rendered. It is important to distinguish between gross income, the total amount earned, and net income, the amount remaining after deducting business expenses. Common deductible expenses include home office costs if the space is used regularly and exclusively for business, vehicle expenses for business travel (either actual expenses or the standard mileage rate), and business supplies. Other deductible expenses may include software subscriptions, professional development, business travel, marketing, and professional fees for services like legal or accounting assistance.

Methods for Tracking Income and Expenses

Various methods are available for tracking self-employment income and expenses. Manual methods involve using physical notebooks or simple ledgers to record transactions, requiring diligent manual entry and calculation.

Spreadsheets, such as Microsoft Excel or Google Sheets, offer a more structured approach. They allow for the creation of columns to organize data by date, description, category, and amount, facilitating basic calculations. Spreadsheets still demand consistent manual input and categorization of each transaction.

Accounting software designed for small businesses provides a more automated solution. These programs can categorize transactions, reconcile bank accounts, and generate financial reports. They often integrate with bank accounts, pulling in transactions automatically and reducing manual data entry errors. Dedicated business banking tools also assist in tracking by separating business and personal transactions, simplifying tax preparation.

Establishing and Maintaining Your Tracking System

Establishing an effective tracking system begins with separating your personal and business finances. Opening a dedicated bank account for all self-employment income and expenses is highly recommended. This separation provides clear financial records, simplifies bookkeeping, and helps identify potential tax deductions. Commingling funds can complicate financial record-keeping and may even jeopardize liability protection for business structures like LLCs.

Once finances are separated, choose a primary tracking tool—whether it’s a manual ledger, a spreadsheet, or accounting software—that aligns with your business’s scale and complexity. For instance, setting up an accounting software involves creating accounts for income and expense categories, while a spreadsheet requires establishing relevant columns. This initial configuration lays the groundwork for consistent record-keeping.

Maintaining the system involves consistently recording all income and expenses as they occur, ideally on a daily or weekly basis. This includes inputting transactions into your chosen software, updating spreadsheet rows, or logging cash transactions in a physical ledger. Regularly reconciling your recorded transactions with bank statements ensures accuracy and helps identify any discrepancies. Additionally, periodically reviewing and correctly categorizing transactions is important for accurate financial reporting and maximizing tax deductions.

Organizing and Storing Your Records

Proper organization and storage of your financial records are important for compliance and future reference. Essential documents to retain include invoices, receipts for all business expenses, bank statements, and payment confirmations. If you use a vehicle for business, maintaining a mileage log is also advisable.

Records can be stored digitally or physically. Digital storage options include cloud services and external hard drives, which offer accessibility and can reduce physical clutter. Scanning physical receipts and documents into digital formats is a common practice. For physical records, using organized folders or binders, categorized by year and type of income or expense, helps maintain order.

Regularly backing up digital records is important to prevent data loss. The IRS does not require specific record types, but your system must clearly show income and expenses. Generally, tax records should be kept for at least three years from the date you filed your original return. However, it is often recommended to retain records for six to seven years, especially if there’s a possibility of underreporting income by more than 25% or for specific deductions like bad debts. Records related to property should be kept until the period of limitations expires for the year the property is disposed of.