Running a small business is as fun and easy as you’d expect, and more people should do it. I’m an unabashed promoter of self-employment, not because it will make you rich quickly (getting rich quick is the wrong goal on the wrong time frame), but because it will make you self-employed. That’s my unfortunate literal tendency which I can never seem to keep suppressed for long.
Saverocity’s glorious leader Matt recently posted on the Forum a request for suggestions about what he should include in an entrepreneurship course he’ll be leading. I assume he’s going to include all sorts of important lessons about networking, flexibility, failing fast, and all sorts of other things I never learned.
Instead, I thought I’d share a few things I wish someone had told me before I became self-employed.
1. Immediately apply for an EIN and use it for everything
I’ve written about this before, but the fundamental lesson is this: the IRS “prefers” you use your Social Security Number for your tax and payment documents because the IRS thinks your business is going to fail. If your business is not going to fail, then it’s going to be a pain in the ass to start using your EIN in the future when you want to hire people, apply for business credit cards, open business bank accounts, etc.
Apply for an EIN immediately here, and use it for everything, the IRS’s “preferences” be damned.
2. Use (and adapt) this spreadsheet
I created this spreadsheet to calculate my own quarterly self-employment tax liability, retirement savings account eligibility, and earned income. Obviously I wish someone had given it to me so I didn’t have to make it myself!
That basic spreadsheet gets me within $2-3 of my self-employment tax liability every year.
Once you have a spreadsheet that you’re plugging your income and expenses into each month, you can start tricking it out with additional calculations. My own has calculations like the self-employment retirement plan contributions I’m eligible for, earned income (to see if I qualify for the Earned Income Credit), and others.
3. Starting a self-employment retirement plan is easier than you think
The government makes it inhumanly difficult to find, fill and file required taxes and paperwork properly. But private companies actually want your money, and make it substantially easier.
When I finally got around to opening a solo 401(k) for my business, it was laughably easy. Just download the paperwork from Vanguard, correctly identify your beneficiaries (I didn’t), and choose your mutual funds wisely.
Why start a self-employment retirement plan? Because you can contribute the first $18,000 you make and deduct that contribution from your taxable income (assuming you don’t contribute to a retirement plan at another job), plus 25% of every dollar you make after that (up to an annual limit). This makes self-employment extremely tax-advantaged compared to employment, since your ability to shield income from present-year taxes at a traditional job depends on your employer’s contributions to your plan. If you’re the employer, you get to decide those contributions, and they can be very high.
4. 92.35%, or 0.9235
For very simple, but extremely boring reasons, you never use your actual net self-employment income for anything: you use 92.35% of it (you can see this on line 19 of the spreadsheet in item #2).
So in item #3 above, I said you can contribute your first $18,000 in self-employment income to a solo 401(k) plan. I was lying. You can contribute $18,000 of your first $19,941 in self-employment income, because the federal government is waging a war on entrepreneurs and the self-employed.
5. Per diem meal deductions while traveling
When traveling for your business, you can deduct the actual cost of your meals subject to fairly complicated restrictions, or you can deduct the federal government’s “meals and incidental expenses” amount for each full day of travel and half that amount for the day you arrive and leave.
It is a pain in the ass to find these rates each time you travel; bookmark this page.
6. Every dollar you spend costs 85.8 cents or less
As you can see looking at the spreadsheet in #2, if you increase your expenses by one dollar, the amount of your income subject to tax falls by 92.35 cents, and the amount of self-employment tax you pay falls by 14.12 cents. That means the net cost of spending a dollar on your business is, at a maximum, 85.8 cents. If your income puts you in a higher tax bracket, the cost is even lower.
This discount is worth taking into account when you see opportunities that might have value to your business: what might not be worth $1,000 may well be worth $858.
Conclusion
I bragged on Twitter that I had 8 things I wish I knew before starting a business, so for now consider #7 and #8 reserved for a future post.
Wow. I have been self employed all my life(long time) and only knew 2 of those!
Great tips – dumb question that I could probably just as easily google, but its probably meaningful to other readers — what are the limitations on contributing to a self employment retirement plan if you already contribute to a employer sponsored 401(k) or equivalent? (e.g. what options for contributing to a retirement plan do folks with side gigs have?)
Trevor,
I have been planning a post on this exact topic. The basic rule is that your $18,000 in employee contributions to 401(k) plans is capped across all of your employers. It’s one $18,000 bucket you can split up however you like (for example to maximize your employer match in one account, maximize your access to low-cost index funds in another account). The $54,000 maximum in employer funds is per-employer, however with all of your self-employment and companies and partnerships you control counting as a single employer. So a person who makes $144k in self-employment income and $144k as an employee at a company they don’t control can save $18,000 in their employer plan with a maximum match of $36k, then contribute another $54k in employer contributions to their self-employment 401k. If they had two jobs at companies they don’t control, they can get up to $54k in employer contributions per company (plus whatever they decide to do with their solo 401k).
So basically: $18k in employee contributions across all plans, $54k total per plan, and all your companies you control count as a single plan towards the $54k limit.
—Indy