First things first, you’re an independent contractor now and you need to treat your consultancy like a real business. That means you need to see an accountant –– ideally before you land your first client. Here’s why that’s so important:
- Taxes: you are very smart. That said, you will not set aside enough money in your first year of consulting to cover your Federal and State income tax requirements. The requirements on 1099s are complex and you need a guide who thinks about tax law and its implications. Think of it this way, your accountant is your consultant specializing in all matters related to taxes. Your accountant will explain why it’s important to prepay income tax quarterly over the course of the year vs. paying a lump sum at tax time.
- Expenses: Ask your accountant for a list of all items that may be tax deductible for your business. Keep records of these expenses, including but not limited to meals, research of any kind, subscriptions, memberships, costs for equipment, software, office supplies, and your cell phone since these are all legitimate to running your business. You will be glad to have these expenses (deductions) at the ready – neat and digitized – at tax time. Tools like Mint.com, Freshbooks.com, Pocket Expense, and Expensify are good places to start to help you get organized. What do you use?
- Break-even Even if you’re a finance wiz and use pivot tables to manage everything from marketing budgets to organizing a conference agenda, it’s worth having a conversation with your accountant regarding break-even. Add up all of your monthly expenses and figure out what income your consultancy needs to generate after business expenses and taxes to cover the expenses of your life.
- Things your accountant may say that will be upsetting: If you have a home office, it must be a dedicated space for running your business. That means if you have a desk and a bed in the same room, it’s not an office, it’s a bedroom and it isn’t a deduction.
- Did I mention that you should prepay your income tax quarterly? Do that. (I didn’t know/do so and man, that hurt!)
Do I need an LLC? Should I turn my consulting into a C Corp? Or maybe an S Corp? Is that expensive? Your accountant will have good advice for you on the tax benefits available to you if you form an LLC. From a tax prepayment perspective, it can be a big help. If you form an LLC, your clients will bill the LLC and not you the individual. From there, your LLC will put you on the payroll and pay you a salary (taking out all the usual deductions). For some consultants, this is reason enough to set-up an LLC. Additionally, there are tax benefits to the LLC that are not provided to independent contractors. Your accountant is the best source for guidance on incorporating or not, and figuring out the best timing to do so.
Here’s what I would have done differently in year one: talk to my accountant earlier in the year to start prepaying income tax and I would taken better advantage of one of the cloud accounting tools listed above (I like Freshbooks) to organize all of my business expenses –– not just the expenses reimbursed by my clients.
Lastly, when you’re hustling for your first client, you won’t be thinking about collecting the expenses you’ve accrued while setting up your business and chasing clients. So, in case you missed this point: go see an accountant and make her your accountant. Now.