9 Things Your Freelancer Clients Need to Know
If you have clients that are like the solo entrepreneurs I saw when I was working as a CPA, getting information from them to do their tax return is like herding cats.
Tax time for my old freelance clients was terrifying. Many had no idea if they made a profit, and they certainly didn’t have anything set aside to pay their taxes.
These days, I’m working full-time as a freelance writer, so I’ve been on both sides of this issue. I’ve pulled together tax returns from shoeboxes of receipts, combined with handwritten lists of income and expenses plus maybe some bank and credit card statements thrown in for good measure. I’ve been the one delivering the bad news that they have a big tax bill.
And for the last two years, I’ve been the one balancing payments from clients against my business expenses and living expenses. I’m the one who cuts those scary checks to pay my taxes. I also interact with a ton of freelance writers who don’t have the business background I have, and who are completely stressed about money and taxes.
So, as both a formerly active CPA and current freelancer, I have a few things that most of your independent contractor or “gig worker” clients need to know to be successful:
1. Treat Your Business Like a Business
If you’ve ever had to defend a client against the hobby-loss rules in an IRS audit, you know that the best defense is demonstrating that your client treats the activity like a real business. That means having a business plan, consulting with experts, having the appropriate skills, among the other factors the IRS considers. This is also a necessary mindset shift that helps your client make the leap to a successful career as a solo entrepreneur.
2. Open a Separate Bank Account
This may seem obvious to us accountants, but I am always surprised by the many freelancers and gig workers I’ve met who run their businesses entirely through their personal bank accounts. For these freelancers, opening a separate bank account – and a business bank account at that – may seem like an unnecessary extravagance, especially at the beginning, when bank fees eat up precious profits.
But as we know, running everything through a separate bank account makes tax time a whole lot easier. And even though it’s not the best way to run a business, keeping tabs on the account balance is a quick and dirty snapshot into the financial health of that business. At the very least, your client can tell if they’re not making a profit.
3. Get All the Required Business Licenses
Most likely, this will be required for opening a business bank account. What’s needed will vary according to location and business type. For example, here in rural New Mexico, I had to visit my county zoning department and apply for a business license.
I also had to register to pay gross receipts taxes to the state. Having a business license is part of treating a business like a business.
4. Don’t Spend Everything You Earn
In contrast to a W-2 job, the paycheck for a 1099 worker isn’t fully available to spend freely. That cash also has to cover business expenses and taxes, at the very least. And hopefully, your clients are also setting aside funds for retirement and long-term savings (more on that below).
When my friend Jessica started writing full-time, she was earning enough to just cover her living expenses. Even though I urged her to set aside part of every deposit for taxes, and to find ways to earn more money, she just couldn’t get it to work. So, when tax time came around, she had no cash to pay her taxes and had to set up an installment agreement with the IRS.
5. Develop a System for Tracking Income and Expenses
Stuffing receipts in a manila envelope and handing them over at tax time isn’t a system. Sorting those receipts into categories and putting them in folders is barely a system. A minimal system is tabulating all the numbers in a spreadsheet. However, thanks to cloud accounting software, there’s an easier way.
Cloud accounting software like QuickBooks Online, Xero, FreshBooks or Wave can import transactions directly from banks and credit cards. Bookkeeping is no longer a burden. I hate data entry, and was never much of a bookkeeper, but I only need five minutes a week to keep my books up to date.
Offer to set your client up with one of the above options and show them how to refresh their bank feed and categorize expenses. There may be a nominal monthly fee, but they will save on tax prep fees and will always know where their business stands.
Most of these also make it easy to send professional-looking invoices, and frequently offer options for clients to pay by credit card by clicking a button right on the invoice. This helps your clients can get paid faster, and they won’t need a merchant account.
6. Develop the Habit of Long-Term Saving
One of my writing clients introduced me to Mike Michalowicz’s Profit First system, which is explained in his book of the same name. When I started writing full time, I implemented that system to manage my business finances.
Profit First is a variation of the old envelope system for budgeting money. With the envelope system, the cash proceeds from every paycheck get split into various envelopes for things like “Mortgage,” “Groceries,” “Electric Bill,” and “Vacation.” Only the money inside that envelope can be used to pay that particular expense.
Following the Profit First system, on the 10th and 25th of every month, I add up all the sales deposits to my business bank account and split them among separate accounts for long-term savings, owner’s compensation, taxes, and operations using specific allocation percentages.
I also have accounts to save for conferences and a new computer. Long-term savings, or profit, comes off first (hence the name). That way I am guaranteed to make a profit from my business. Making a profit is the best way to defend against the hobby-loss rules.
This limits the resources available for paying my business expenses and for paying myself. It takes discipline and sometimes means hard choices. It also lets me know how much I need to make in sales each month so I can pay myself enough to cover my living expenses.
Tax time is vastly less painful because the money is already set aside. All I have to do is write the check. Last year, my tax account had a surplus, so I put it in my IRA.
Michalowicz concedes that the saving and discipline can be tough, so once a quarter, he recommends taking half the balance in the profit account and paying it out as a bonus for something fun. At first, it was just a nice dinner. Now my quarterly bonuses pay for vacations.
7. The F-U Fund and the Survival Fund
The Profit First system may be too hard for some to manage. John Carlton, a well-known and wildly successful direct response copywriter, urges freelancers to set aside two chunks of cash: the F-U Fund and the Survival Fund.
The F-U Fund should only be tapped in the dire situation when your client needs to walk away from an engagement. It should be enough to cover between three months’ and three years’ worth of living expenses, whichever feels most reassuring. Having a stash of money set aside will give your freelancer clients the confidence to say no to bad situations and to seek out better work.
The Survival fund is used to cover the inevitable slowdowns that are part of being self-employed. Carlton suggests saving enough to cover between one month and one year’s worth of expenses.
These accounts can be populated by setting aside a portion of every payment, maybe 10% or so, or, as Carlton did, depositing every other check in those accounts.
8. Save for the Future
Like me, you’ve probably seen at least a few clients with healthy incomes who spent virtually all the money that came their way. I saw a surprising number of successful professionals with salaries or income distributions in the mid-six figures but virtually no investment income, and who weren’t setting aside much – if anything – in retirement accounts.
Self-employment means you are your own safety net. I was fortunate to have a good start on my retirement savings from previous employers, but some of your freelancer clients may not have much – if anything – saved up for retirement. Make sure you lay out all the options for retirement saving and help them select one that makes sense.
9. Does Your Pricing Model Make Sense?
Pricing is challenging for accountants and freelancers alike. In the writing world where I work, many freelancers have standard rate sheets that they use as a basis for billing clients. Ilise Benun, a business consultant for creative professionals, suggests developing minimum billing rates for projects by estimating the hours it will take, and multiplying that by one’s desired internal hourly rate. This minimum billing rate isn’t disclosed to prospective clients but serves as the absolute minimum price for a project.
The internal hourly rate is calculated by dividing the total amount of cash a business needs to bring in to cover all expenses – including taxes and the freelancer’s living expenses – by the number of hours a person wants to work in a month. For example, if your client needs to bring in $10,000 every month, and they want to spend 30 hours a week on paid projects, they’ll need to make on average $83.33 per hour ($10,000 / 120 hours). If a particular project or service takes eight hours to complete, a minimum rate would be 8 x $83.33, or $666.67.
If your client is only charging $200 for this service, they may have a tough time earning enough money to make ends meet. Walking your clients through this pricing exercise can help them figure out if they’re charging enough, or if their business model is realistic.
Be The Advisor Your Clients Need
These are just a few of the special issues that come up for freelancers. These may seem obvious to us as practitioners, but many freelancers and gig workers don’t have clue about taxes or managing their finances. Helping your self-employed clients with these thorny issues will make you a hero in their eyes.
Liz Farr, CPA, spent 15 years in tax and accounting at small firms in Albuquerque, NM. Besides tax returns of all flavors, she worked on audits of governmental entities and not-for-profits, business valuations, and litigation support. Now she's a full-time freelance writer specializing in content marketing for accountants and bookkeepers around...