I’m a big fan of the author David Foster Wallace, but when I opened his posthumously published book, The Pale King a few years back (its protagonist an employee of the IRS and the entire theme a testament to the boredom pervading American life) I had to shelve it for later. At the time, mere mention of those three acronymical letters — in conversation, on a page, in any order — inspired cold sweats, if not tears. I’d been slapped with a $5,222 federal tax bill and was slowly repaying it through a process that felt like giving blood one drop at a time.
But my predicament was on me — I’d foolishly believed that all the money I made was my own.
I’ve been a contractor my whole adult life, which has meant waitressing, babysitting, and yoga-teaching my way through the poverty line. It has meant making a healthy amount of “self-employment” income at a part-time graphic design job because my employer wouldn’t cover my benefits, 401K, or Social Security unless I signed on to a nine-to-five — which, as an artist, I resisted. But mostly, it has meant figuring out shit as I go, and recently, it’s taken me from tax repayment plan to business owner.
The following are steps I’ve retraced in hindsight — they are the things “I wish I’d known then.” In no way is this a complete guide to getting over your fear of the IRS, nor will it help everyone in every scenario. I’m crafting it in hopes that it will reach people like my 2014 self. (For what it’s worth, I recently completed my 2017 tax call, and my preparer said I might be eligible for a refund this year.) Needless to say, The Pale King is back on my bedside table.
So, you wanna be an independent contractor? Not so fast.
Educate yourself —
Make sure you know about the self-employment tax (this is in addition to federal, state, and local income taxes) before quitting all ties to your workplace. Formally known as the SECA tax for Self-Employment Contributions Act tax, this is 15.3% of your earnings up to $127,200, and it covers the amounts your employer would normally withhold for Social Security and Medicare. While there are a few silver linings to be aware of here (i.e., half the tax can be deducted from your total earnings), I want to focus more on woulda-coulda-shouldas, rather than getting into the nitty-gritty of the tax code.
To put things in perspective: one way I could have avoided my $5,222 tax bill at the end of my first year making money as a contractor would have been to save for my taxes as I went — literally setting aside $153 per $1,000 that I made (plus, depending on my annual income bracket, an additional 10-39.6%, or $100 to $396), and then making estimated quarterly payments throughout the year, as, in fact, the law requires. (Trust me, I know from experience this is easier said than done — especially since now you’re also buying your own health insurance (deduct that shit!), saving for retirement, and of course, still have bills to pay.
Which brings me to my next suggestion:
Charge more —
There are a lot of handy resources that can help you determine what your hourly rate should be as well as basic formulas for calculating it. Make sure to build your new obligations — the costs of doing business and your taxes — into it. Of course, the more you make, the more you’re taxed. So you may want to consider incorporating and billing from your LLC.
The Supreme Court has consistently ruled that corporations aren’t much different than people — but whether you are a company or a contractor can significantly affect your tax bill. My experience has been that incorporation helped me and my clients take my work more seriously. Cultivating a brand beyond my own name ultimately gave me the freedom to serve more clients and do more fulfilling work than contracting for one or two companies. Take time to consider how entrepreneur-izing might change your life. Reframing yourself as a business — not just to the IRS but to yourself — could make a difference to your bottom line, through mindset alone.
Elect to be taxed as an S Corp —
This step happens after incorporation and an accountant will be happy to walk you through it (it’s very important to find a bookkeeper and tax preparer that you trust). S Corporations’ profits and losses “pass through” the LLC to you, its owner, so your taxes will be based on whether or not you profited throughout the year. Also, you’ll be required to pay yourself as an employee along with payroll taxes as you go.
Prepare for additional expenses and paperwork —
When you start a business, there are extra forms and filings you’ll need to be aware of throughout the year in order to stay compliant in addition to basic accounting requirements. Do your research to help you determine if this kind of commitment is even worth it to you, and definitely take the swarm of vendors who will want to sell their services to your business with multiple grains of salt. Know that there are ways to streamline, as well as useful things worth spending money on: buy or build as you go a compliance calendar of all the different deadlines and make sure to set plenty of reminders so you’re prepared each year.
Since you pay taxes on whether your company showed a profit or loss, you’re allowed and expected to weigh all “ordinary and necessary” expenses against your gross revenue. Your yearly profit and all shareholder distributions (money you can take from your business at any time, but which is not a deductible expense) together comprise what the government will want their fair share of. Independent contractors also should deduct business expenses in order to lower their taxable income.
Consider your state of incorporation —
For example, in California, almost everyone with an LLC pays a minimum annual franchise tax of $800. This may or may not be a deterrent to incorporating, but it’s definitely important to be aware of in advance. And if your business is digital in nature, requiring no physical location, you may want to partner with someone in a state with more favorable tax codes. Do not take this suggestion at face value, however, as with all aspects of this process, there’s a lot of nuance to understand before taking action.
And if you’re planning on buying a home…
Lenders want to see two years of qualifying income, which your pass-through business may technically reduce if you deduct a lot of expenses. Speak to a mortgage lender two to three years (yes, years) before you think you might want to become a homeowner so you can get an idea of how the process works and set appropriate financial goals.
Lara Wilson Townsend is a writer, dancer-choreographer, and brand designer. When she’s not directing @theassemblydance, she and her husband can be found manning their newly-opened art and event space in Yucca Valley, @compoundyv. Come visit!