Stepping into the freelance world, part 5: rendering unto the tax collector …

03 Mar

Posted by Scott as advice, consulting, tips

tax Taxes. It’s not a four-letter word, but it may as well be. I won’t go into the reasons why people dislike paying taxes — we all have our own. But if you want to play (or, at least, stay in business) then you’ve got to pay.

For the full-time employee, paying taxes is relatively easy. Employers deduct tax at the source, and at the end of the year you file an income tax return. If you’re lucky, and any other income that you have to pay taxes on isn’t too high, then you might just get some money back.

For the freelancer, though, it’s a little different. For the most part, we work in a world where we bill clients and they pay us whatever sums we charge. We’re expected to pay taxes on those sums. That’s where things get interesting, and here’s some advice on how to make things in that sphere a little less interesting.

Note: I’m not a tax or financial expert. Everything I talk about in this comes from my experience. I suggest getting more detailed advice from a professional.

Keeping the books

Like anything else, your finances can benefit from your being organized. You need to keep track of everything — income, expenses, and salary. Not only does this give you a good picture of where you stand financially, it can help you determine how much you need to pay in taxes.

The easiest ways to do that are to make sure you properly invoice your clients, and keep track of all payments received and of all your expenses.

Let’s look at invoicing first. The easiest way to do this is to create an invoice in your favourite word processor and email it to the client. A quick and dirty solution, but not the best one. As I mentioned in a previous post, Aaron and I use an online billing tool called Blinksale. Blinksale lets us customize our invoices, automatically calculates the goods and services tax) (in your case, that might be sales tax or VAT), and lets us email the invoice automatically. We can also run reports on the invoices to determine how much DMN Communications has taken in over a specific period.

Overall, though, the easiest way to track payments received and expenses is with a spreadsheet. Aaron and I maintain separate spreadsheets. We break our expenses down by the month, and then send the spreadsheet to our accountant at tax time. We do the same with cheques and payments that we receive — we break it down by client name, date received, amount, invoice number, and cheque number. Again, we send that spreadsheet to our accountant in January or February.

What about salary?

That’s a somewhat different beast. If you’re incorporated, then things are slightly different. You usually invoice your client in the name of your company, and then draw a salary from the company. As a sole proprietor or an unincorporated partnership, I believe that whatever you make is considered income. And you’re pushed into a higher tax bracket.

That’s definitely a benefit of incorporation. You’re paying two sets of taxes — one for the corporation, and one on the amounts that you draw in salary. However, if you do it properly, your overall tax burden will be lower. If you’re unsure about whether or not to incorporate, and if you want to learn more about the tax benefits of incorporation, consult a professional.

Expenses, expenses

A lot of things fall into that category. Computer hardware and software. Office supplies. Rental of office space. Business travel expenses. And more. It’s definitely worthwhile keeping track of your expenses. They might help reduce your tax burden, and if you’re incorporated you can get the company to pay many of those expenses.

Again, a spreadsheet comes in handy. As I mentioned earlier, Aaron and I break our expenses down by the month, and then send our spreadsheets to our accountant at tax time. We also keep every receipt. Don’t just stuff your receipts into an envelope or a box. Order them by month, preferably in chronological order. It’s a bit of work, but worth it.

Banking

Chances are, you have a separate bank account for your business. If you don’t, you should. It make things easier when tax time rolls around, and allows you to automate your payroll. That might cost extra, but it is definitely worth it.

Something else to consider is setting up a tax account (also called a contingency account). Deduct tax from every payment that you receive from clients and transfer it into the tax account. That way, money accumulates and you won’t be happy slapped by the amount that you need to pay at the end of the year.

How do you know how much to set aside. That’s where a good accountant comes in.

Retain an accountant

An accountant can be expensive. But a good one is worth his or her fee. (If you’re in the Greater Toronto Area and are looking for a good accountant, contact us and we’ll put you in touch with our accountant.)

What can an accountant do for you? Here are a few things:

Prepare your business and personal tax returns
Help you figure out how much to set aside for your tax account
Advise you on deductions and how to (legally) keep more money in the pockets of you and your business
Work with you to help expand your business

And a lot more.

Summing up

I’ve probably missed a couple of things in this post. But, as I said, I’m not a tax or financial professional. I only wanted to give you an idea of some of the factors that you should consider when tax time rolls around. Organization and preparation are the key. Add to that a little professional help, and you can keep the tax authorities off your back and keep a little more money in your coffers.

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