Budgeting and Tax Advice for the Self-Employed

Are you working on a startup concept now or hoping to be self-employed at some point in the near future? There are a number of strategies you can embrace now that will improve your chances of success later, says Jim Sharvin, a CPA who focuses his Torrance (Calif.)-based accounting practice on small business owners and the self-employed. He says he cringes when he sees the many pitfalls that entrepreneurs could easily avoid—if only they knew how. Here are a few of his startup budgeting and tax tips.

Start saving now. Having an ample capital cushion is essential for surviving the lean-cash-flow months of a startup company. "Every entrepreneur thinks that their product or service is better than anybody else's. They know that everyone will come and buy what they're selling," Sharvin says. What they're not counting on is how long it takes to ramp up sales, how much upfront investment a new company requires, and how long collections can lag invoicing. If you're paying into a 401(k) plan at your current job, consider reducing your contribution down to the level of your employer match and putting the extra money into an automatic savings account that will become a seed fund for your new business.

Write a simple business plan and show it to your critics. "Have somebody who's in business look at your plan. Make sure it's someone who's not afraid to say you're full of crap," Sharvin says. Take the criticism seriously and rework the plan—then show it to several other knowledgeable individuals. "Tweak your plan a few times and you'll be ready to hit the ground running when you start your company," he says.

Price it right. "People who used to be hired out for $150 an hour by their employer think they can charge $75 an hour once they're self-employed," Sharvin says. "You'll get the job if you go that cheap, but you'll work for nothing." You must figure not only your time, but your company's overhead into your hourly rate. Don't let large clients take advantage of your size. "People often see a small business and figure it is going to be a bargain for them to do business with," Sharvin says.

Set up a budget. You can use business software but it's just as easy to get familiar with the Excel spreadsheet you likely already have loaded in your computer, Sharvin says: "Put your home budget on there and then add your business expenses on top. It's not that complicated." Once you're in business for yourself, revisit your budget on a monthly basis to see how actual expenses are matching up with your projections. Figure out where you may have to tweak costs or boost revenues so reality lines up with your expectations.

Don't forget about taxes. Once your business becomes profitable, you will have to pay federal self-employment tax, typically on a quarterly basis. Make sure you also budget for state, municipal, and school taxes that apply in your jurisdiction. If you establish yourself as a sole proprietor or S-Corp, file jointly, and don't have the cash flow to make quarterlies early on, your employed spouse can increase the withholding from his or her salary. "The payroll department at your spouse's employer can help you figure out how much extra to withhold during each pay period," Sharvin says. While your household will have to live on less take-home pay—or your spouse may need to temporarily reduce his or her 401(k) contribution—your company can skip quarterly payments and it won't be hit with penalties at tax time. "Just make sure you change your exemptions back once your company is able to make quarterly payments," Sharvin says.

Establish a separate tax account. "I tell my clients this and they absolutely hate it. They think I'm the tax devil," Sharvin says. Why? Because he advises them to divert 40% of their self-employment revenue into an account that they will use to pay federal income tax, self-employment tax, and state and local taxes. "People think it's not fair, but the reality is when you get $1,000 in the mail from a client, it's not all yours when you're self-employed. You pay taxes when you're employed, but it's taken out before you get your paycheck, so you just don't notice it as much," he says.

Hold off on establishing a company retirement account. "People sock a bunch of money early on into a SEP-IRA or a SIMPLE 401(k), then they raid those accounts when they run out of capital and their business is hurting," Sharvin says. "If you take the money out, you pay taxes on it—and a penalty. And in some states, like California, you'll have both state and federal penalties." Get through the startup phase and be sure your company will succeed before you set up a retirement account. Remember that pension contributions can be made up until you pay your taxes, including extensions, Sharvin says: "If you start a business in 2010, you have until Oct. 15, 2011 to set up and fund a SEP-IRA."

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