Everyone has a side hustle these days. Earlier this year, Bankrate released a report claiming over 44 million American adults are earning money outside of their main source of income.
Of course, I’m one of them. I started freelance writing as a side hustle in October of 2015 and turned it into a full-time gig ten months later.
Maybe you’re considering a freelancing to save for a big purchase, pay down debt, or just pursue a passion you hope to eventually take full-time.
Unfortunately, many people don’t consider the financial aspects of the side hustle until they’ve made a few mistakes. Whether your freelance work earns just a few dollars a month or a several thousand, tracking your profits and paying taxes are non-optional. Here are a few essential steps to get started on the right foot.
Apply for an Employer Identification Number (EIN)
Often freelancers and side hustlers will start out using a Social Security number for their business rather than an EIN. For sole proprietors, there’s nothing (legally) wrong with that.
But do you really want to give your SSN out to every client you work with? Probably not.
Anyone that pays you more than $600 per year should ask you for a Form W-9 and issue a Form 1099-MISC to you at year end. Form W-9 is simply a tool for collecting the info your client or customer will need to prepare the 1099. Form 1099 is an informational return, used to help you accurately report your income to the IRS. The IRS also receives a copy so they can compare the 1099s received on your behalf to the income reported on your return.
Sole proprietors can use a Social Security number to complete Form W-9, but using an EIN is better.
The good news is that applying for an EIN from the IRS is free and can usually be handled online in just a few minutes. You’ll get your EIN immediately upon completion. Just be sure to save a copy of the letter assigning your EIN, you’ll need it later.
Prepare to get paid
How will clients pay you? While I have a few clients that still mail paper checks, they’re in the minority. Most companies prefer electronic payments these days.
PayPal is a quick and easy method for invoicing and collecting payments from customers and clients. In fact, you may already have a personal PayPal account that you can upgrade to a business account for free.
A business account permits you to withdraw larger amounts on a daily basis than you can with an individual account.
Stripe is a good option for recurring invoices, such as subscriptions, but their invoices are not intended for one-time charges.
I’ll admit that I set up a Stripe account, but I’ve never used it. All of my clients prefer to pay me via other methods, but I have the account if I need it. However, I know that it gives you the ability to accept all major credit and debit cards from customers, as well as ACH Debts, Bitcoin, and more. Once you’re set up, you can choose to have money received through Stripe transferred to your bank account on a 2-day rolling basis, weekly, or monthly.
The downside is that PayPal and Stripe are costly. When you receive money for goods or services, both platforms charge a fee of 2.9% of the transaction, plus $0.30. International payments may cost even more. However, they’re widely used and give you a secure way to make it easy for clients to pay you.
In a recent Facebook group for freelance writers, a member expressed concern that a client has asked for her bank routing and account number. While a few members of the group were skeptical that this could be a legitimate request, many of my freelance writing clients (including Forbes!) pay me through ACH.
ACH stands for Automated Clearing House network. It’s a secure system for clearing electronic payments through banks – similar to having your employer direct deposit your paycheck.
Your client may use Bill.com, in which case they’ll send you an invitation to set up a Bill.com account to get paid. Other clients may send you an ACH authorization form that requests your bank account information. It’s probably a good idea to confirm that your client is legitimate before handing that information over. The clients that pay me via ACH (Magnify Money, Credit Karma, Forbes, and an accounting firm owned by my good friend and former co-worker) are established, trustworthy companies. I would not give my bank information to some random Craigslist client! If you’re not sure, ask them to pay via PayPal or Stripe.
Track revenues and expenses
One of the first things many of my former clients asked when they started a side hustle was whether they should use bookkeeping software. When I worked for an accounting firm, I used Quickbooks regularly. And I tried out Xero when I started freelancing. They’re both great products, but for many side-hustlers, they’re overkill.
Most side-hustlers need a simple way to track money in (income) and money out (expenses). You likely don’t need to track depreciation on a building or machinery, process payroll, or track basis. You don’t really even need to understand the difference between debits and credits or what the retained earnings account is used for.
So for that reason, I recommend FreshBooks. I’ve been using Freshbooks for over a year in my own business and I write for them as well. What I like about it is how simple it is to manage the accounting for my business. Yes, I’m a CPA and I understand double-entry accounting and MACRS depreciation, but honestly spending hours posting journal entries is the last way I want to spend my time.
I track projects and invoice clients directly from FreshBooks. They can choose to pay me via credit card through FreshBooks or send me payment via PayPal, Stripe, ACH, or paper check.
I connected my bank account to FreshBooks and every time money leaves my account, the expense is recorded. Freshbooks can identify and automatically record many transactions, others take me just a couple minutes a week to classify. Plus, I can attach a copy of the receipt or other documentation right in the software. That saves me from digging through piles of receipts at tax time and will be my saving grace if I’m ever audited by the IRS.
You can try Freshbooks for free for 30 days. If you like it, their Lite account allows you to bill up to five active clients and costs just $15 per month. That’s the plan I started out on, but I’ve since upgraded as I’ve brought on more clients.
However, I know that for many side hustlers, bookkeeping software seems unnecessary, especially when you’re just starting out. If you’re not ready to invest in software just yet, a simple spreadsheet will suffice. Simply create a column for revenue and columns for each expense category, such as advertising, office supplies, subscriptions, etc.). Microsoft has a free template that will work for most PC users.
BUT . . . entering transactions from your bank account into a spreadsheet is not a good use of your time. I’m a firm believer in automating wherever you can and investing the saved time in better ways. If you are taking your side hustle seriously, I highly recommend investing in a FreshBooks account.
One more tip: always save your receipts! Whether you maintain a paper file, snap a photo or scan and save them electronically, you’ll need them if you’re ever audited. If the IRS comes knocking, your profit & loss statement or bank statement won’t be enough.
Separate business & personal expenses
You’re not required to set up a separate bank account for your business, but keeping your business and personal expenses separate provides several benefits. First, it makes tracking income and expenses easy. It also makes it easier to transition your bookkeeping and tax preparation to an accountant when you decide to hire one. Plus, if you choose to create a formal business entity such as an LLC, keeping segregating business and personal funds helps ensure you don’t “pierce the corporate veil.”
Setting up a business bank account requires a little more documentation than opening a personal checking account. The bank will need a copy of your EIN assignment letter from the IRS and possibly a copy of your business license.
Do a little legwork to find a bank that offers free business checking. Some banks charge fees as high as $14 per month and business accounts tend to have higher minimum balance requirements.
Set aside money for taxes
If you’re new to being self-employed, you’ve probably been receiving a paycheck from an employer, and your employer has been withholding taxes on your behalf.
Once you’re self-employed, you’re responsible for paying income taxes and self-employment taxes (Social Security and Medicare, also referred to as FICA).
For 2017, the Social Security tax rate is 12.4% for self-employed individuals. However, Social Security tax is only assessed on the first $127,200 of earned income.
The Medicare tax rate is 2.9% for self-employed individuals with no income cap. In addition, if you have earned income over $200,000 as a single tax filer or $250,000 as a married couple filing jointly, you’ll be responsible for the additional Medicare tax at a rate of 0.9%.
Since the U.S. has a “pay as you go” system, you’re required to pay income and self-employment taxes quarterly. If you don’t pay quarterly estimates, you could be hit with penalties and interest when you file your return.
Most people are looking for a good rule of thumb for setting aside employment taxes. Should I save 20%, 25%, 30%? Unfortunately, it’s not that easy. The amount of tax you’ll owe when you actually file your return depends on a number of variables that have nothing to do with your business, such as:
- Is your filing status single, married filing jointly, married filing separate, or head of household?
- Does your spouse work and have taxes withheld?
- Do you have investment income such as interest, dividends, and capital gains?
- Do you have dependents?
- Do you contribute to a retirement account or health savings account?
- Are you eligible for any tax breaks for education such as the American Opportunity Tax credit?
Those are just a few examples, of course. The tax code is extensive and many factors will go into calculating what you owe. Your best bet is to work with an accountant to estimate your tax liability.
Once you’ve decided on a percentage, put it in a separate savings account and send an estimated payment to the IRS on April 15th, June 15th, September 15th, and January 15th of the following year. You can mail a check to the IRS along with Form 1040-ES (if you’re a sole-proprietor or pass-through entity), but I recommend using the IRS’s Direct Pay system – it’s free to have the money transferred directly from your checking or savings account and you’ll receive a payment confirmation immediately.
When you’re just starting your side hustle, you may not have the resources to hire an accountant, but that shouldn’t prevent you from getting your business finances set up on the right foot. Spending a little time on it early on is worth the effort. Not only will you be better prepared at tax time, but you’ll also be able to easily transition your bookkeeping to a professional if you decide to take your side hustle full time.
Disclaimer & disclosure: While I am an accountant, I am not a lawyer, nor do I know your individual situation. This advice comes from my personal and professional experience, but your circumstances could be very different. I recommend that you seek the help of qualified professionals. Also, some of the links included above are affiliate links. If you click through and enroll or make a purchase, I may receive a commission. Thank you!