Working as an independent contractor comes with a lot of perks.
You are your own boss, you can set your own hours, and you have more freedom than working as an employee where everything is dictated by someone else.
The flip side is that you don’t have an employer to handle financial aspects such as benefits, taxes, and retirement.
As an independent contractor, you’re going to have to learn to manage these things on your own. This guide will define the role of an independent contractor, why monthly bookkeeping as a freelancer or independent contractor is so important, and how independent contractors handle their bookkeeping and tax liability.
What is an independent contractor?
An independent contractor is someone who is self-employed and is contracted to provide services to or perform work for another entity as someone who is not hired as an employee.
This means that anyone who uses an independent contractor’s services is not required to provide employee benefits or take out any withholding from their paychecks.
The contractor’s clients are only responsible for issuing a 1099-Misc form to the contractor if he or she earned more than $600 during the tax year.
Since independent contractors are not considered employees and aren’t eligible for employee benefits, they must take the initiative and get their own health insurance, plan for their retirement, and make sure their taxes get paid.
Which accounting method should independent contractors use?
Before an independent contractor files a tax return, he or she needs to choose which accounting method they are going to use when keeping their books.
Below are the two main accounting methods:
- Cash basis. Cash basis records income when it is received and expenses when they are paid.
- Accrual basis. Accrual basis records income and expenses when they are earned instead of when they are received. This gives a company a better projection for the future.
How do independent contractors pay their taxes?
For tax purposes, independent contractors are either considered a single-member limited liability company (LLC) or a sole proprietor.
By doing this, the business expenses can offset some of the gross profit which will reduce some of the tax obligations.
What does withholding estimated taxes mean?
Since independent contractors do not automatically have taxes withheld from their paychecks, they must pay self-employment taxes on a quarterly basis.
They must also pay Social Security and Medicare taxes. It’s important to plan for this and set the money aside ahead of time so that the money is available before the tax deadline.
Do independent contractors need to track everything?
One of the most important tasks for an independent contractor is to track every financial transaction.
That means every transaction that brings money in and each transaction that goes out of the business account(s).
This documentation is especially crucial if you are ever audited.
Below are some examples of income and expenses that most independent contractors keep track of with their bookkeeping system:
- Office supplies
- Website costs
- Accounting software
- Internet costs
- Phone bills
- Client payments
- Office rent
- Hours spent working on a project
- Completed jobs
- Paid invoices
- Office equipment
- Bank transfers
- Travel expenses
As far as keeping track of expenses, the IRS considers a business expense as anything that is necessary and ordinary to the business.
For every expense, there should be a receipt. Be sure to have an efficient system for organizing and storing all business receipts.
Since this can be a tedious and time-consuming process, a great option for organizing receipts is to digitize them by using a service such as Shoeboxed which digitizes, organizes, and stores the receipts for you.
Without a systematic bookkeeping system in place, there’s no way you would ever keep track of all of these items.
Also, because there is so much to keep track of, it’s important to stay on top of all of the accounting and bookkeeping duties.
If you fall behind, it’s hard to get caught up and easy for something to fall through the cracks.
Hot tip! Don’t mix business with personal expenses
When trying to track business expenses and income, it’s best if you have a separate bank account set up for your business as an independent contractor.
This will separate your business transactions from your personal expenses.
This separation of transactions will make it much easier when tax season rolls around or if you are ever audited.
It’s essential, especially as an independent contractor, that you keep your business transactions transparent.
How can accounting software help with the bookkeeping of independent contractors?
Knowing how to do the accounting cycle yourself is a major feat. But an accounting software is highly recommended if you are an independent contractor.
Independent contractors, since they are the sole business owner, are responsible for everything that goes on in the business.
Accounting software can at least relieve some of this burden.
Below is a list of ways accounting software assists the bookkeeping process:
- Accounting software ensures more accurate financial records and makes it easier to invoice clients and keep up with unpaid accounts.
- Accounting software generates accurate financial reports so that you can make sound business decisions and helps to keep your financial records organized.
- Using accounting software helps you figure out your tax estimates and makes it easy to reconcile your bank transactions.
- This type of software also automates and streamlines your data, saving a lot of time and money.
Should you hire a professional for their bookkeeping and accounting services?
Typically, independent contractors will start out doing their own books.
This is a good way to save some money when starting your business.
As the business grows, there are more aspects that require your attention, such as acquiring and maintaining clients.
Hiring a professional to take care of the books will give you more time to concentrate on growing your business.
Bringing in a CPA is also beneficial, especially during tax season.
A CPA can analyze your end-of-the-year balance sheet, independent contractor expense sheets, statement of cash flow, income statement, and other financial records and offer invaluable advice on how to proceed in the future.
While hiring a professional may be costly initially, it will save money in the long run.
Frequently asked questions
If you’re self-employed, you’re not required to hire a bookkeeper or an accountant.
However, hiring a professional is highly recommended when it comes to filing your taxes and making your tax payments.
Submitting late or incorrect amount of tax payments can result in penalties and fines.
Yes. QuickBooks Self-Employed is designed specifically for independent contractors.
Yes. The IRS does audit independent contractors. That’s why it’s crucial to keep business and personal expenses separate by opening separate bank accounts.
Being a bookkeeper for yourself and having an efficient bookkeeping system in place is essential if you’re an independent contractor.
Having books that are organized and up-to-date will ensure that clients are invoiced in a timely manner, accounts aren’t sitting around and not being paid, your bills are being paid on time, and you’re meeting your tax obligations.
With this efficient bookkeeping system, financial reports can be generated that will help the business owner make sound decisions about the future. If you are curious, check out our guide for the details about virtual bookkeeping.
Caryl Ramsey has years of experience assisting in different aspects of bookkeeping, taxes, and customer service. She uses a variety of accounting software for setting up client information, reconciling accounts, coding expenses, running financial reports, and preparing tax returns. She is also experienced in setting up corporations with the State Corporation Commission and the IRS.
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