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Working for yourself is an exciting challenge. Millions of Americans dream of being their own boss and want to have their own business, but not necessarily a large operation with several employees and thousands of customers to serve. Thus, the number of freelancers and contractors are on the rise to get the best of being an entrepreneur and having a day job, but find that they’re in for many of the same tax and accounting obligations and are unsure what to do.
Here’s what you need to know about bookkeeping for independent contractors and why it’s important.
What is Bookkeeping?
Bookkeeping refers to the recordkeeping system established for the recording of business transactions. A transaction is an economic event that has some type of financial outcome, like billing a client, receiving payment, or paying expenses.
Common examples for gig workers, freelancers, and independent contractors would include:
• Getting paid for services
• Royalty payments for your own intellectual property (e.g. Medium, Steam, Kindle)
• Buying office supplies
• Dues for professional societies and trade groups
• Business licenses
• Bank and digital payment processor fees
• Business and device insurance
• Mileage and other business travel
Transactions are recorded to the corresponding accounts, such as service revenue and insurance expense. Because bookkeeping for independent contractors has a relatively low transaction volume and the transactions are fairly simple, many are comfortable handling bookkeeping themselves with a spreadsheet or manual accounting system. Systems like Wave, Freshbooks, and QuickBooks Online are popular computerized bookkeeping and accounting solutions for all types of small businesses that independent contractors and gig workers find easy to use, and they also have the option to connect with an accountant to check and correct entries.
Solutions like Wave and QuickBooks also offer options for integrating payment processing with bookkeeping, resulting in fewer transactions to manually record. Most major bookkeeping programs with online and desktop versions also enable bank account integration to easily catch discrepancies and write checks from the program virtually.
What’s the Difference Between Bookkeeping and Accounting?
Bookkeeping refers to the daily summary of financial transactions and ensuring that they are posting to the correct accounts. While the term is used interchangeably with “accounting”, particularly for freelancer accounting as the transactions are fairly simple and low in volume, they actually mean two different things. Accounting refers to the information system used throughout bookkeeping, then checking and compiling all of the transactions into financial statements for external users like banks and business information services, and managerial accounting for internal users like the owner and key decision-makers.
Because independent contractor accounting is for just one user, and it’s common to have less than five transactions per day or even go for several days without any financial activity whatsoever, it’s more common to have “bookkeeping” and “accounting” mean the same thing in this context.
Businesses with a higher transaction volume and/or more complicated transactions have a more urgent need to automate and outsource their bookkeeping to an accountant who knows how to create the correct infrastructure for that volume and complexity.
What Are Books Used For?
Freelancers, solopreneurs, and independent contractors primarily need accurate books for tax reporting purposes. Even though the transaction volume is relatively low compared to other types of businesses, keeping them separate from personal finances makes them easier to organize and also be treated as a business as far as both taw law and the business world are concerned.
While the final numbers used on both business and personal tax returns are treated slightly differently and need to be reconciled for higher-income earners, the information that must be input on the tax forms is coming from the same source. Many freelancers keep track of their earnings and expenses with a spreadsheet and this system can get the job done early in their careers, but find that they need a more robust bookkeeping solution as their careers and earnings grow.
Properly-kept books with an appropriate accounting framework can help provide an accurate picture of where your money is coming from, and where it is going. Accurate bookkeeping shows which clients don’t pay their invoices and should be cut, and which channels should be prioritized and expenses can be cut. Even the smallest businesses need to stay on top of their financial data to make informed business decisions that help them grow and thrive.
Additionally, having accurately running numbers can help independent contractors and solopreneur businesses get financing for their own projects.
Financial statements also need to be produced in order to obtain a business credit file, such as the type one gets with Dun & Bradstreet (which is required to open an Apple Developer account, if you want to sell your own apps and games).
Gig Work and Bookkeeping
While there is much debate on both the federal and state level as to whether gig workers should remain independent contractors or be reclassified as employees, at the time of publishing, they are still considered independent contractors in the eyes of the law. While gig workers aren’t as apt to set up their own companies like professional freelancers and independent contractors do, they need to keep track of income and expenses in a similar manner.
Whether gig workers work with one app or several, expenses need to be claimed against their earnings. If you are only giving gig work a try as a temporary stop between jobs, a spreadsheet should suffice but long-term gig workers tend to need some type of bookkeeping system in place.
The dominant expense in gig work is mileage and related wear and tear expenses on your car. While there are several mileage logging apps to consider, Intuit TripLog and Timeero both integrate with QuickBooks to provide GPS-based mileage tracking.
Other expenses related to gig work like delivery bags, backup phones and chargers, supplies and services for keeping your car clean, and PPE are fully or partially tax-deductible. Setting up a bookkeeping system can help you track these costs as they’re incurred, rather than scouring for receipts and bank and credit card statements at tax filing time.
What if My Expenses Have Both Personal and Business Elements?
Gig workers and freelancers have one common headache when it comes to financial recordkeeping: there are some expenses that are unavoidably personal in nature.
A significant number of independent contractors who are fully focused on their own businesses take the steps to set up the corresponding infrastructure like separate bank and digital payment processor accounts, have their own tax ID separate from their Social Security number, and put a bookkeeping system in place. While this puts them in a different place than an Uber driver who is less likely to set up such a system, there are some common areas where both business and personal use overlap:
• Using part of your home for business
• Phones, computers, and other devices that may not necessarily be 100% for business
• Separating business mileage from personal use of your car
• Using a personal credit card to pay business expenses, since you do not have business credit established yet
These transactions can be booked then later modified as appropriate for tax filing, such as paying for a new phone that you plan on using half for business or gig work reasons, then half for personal. However, if you want to keep separate devices from your personal ones, you are free to do so and 100% of the cost would go on both the books and your tax filings.
For other transactions that may be split between business and personal accounts, such as credit card payments, tools like QuickBooks Self-Employed provide mechanisms for demarcating these transactions and splitting them where appropriate.
How Should Independent Contractors Set Up Bookkeeping Systems?
Freelancers who don’t outsource accounting from the start will need to set up their own chart of accounts in the solution of their choice. While it isn’t recommended that you set up the chart of accounts yourself unless you have an accounting background, independent contractors tend to be relatively simple. QuickBooks remains a popular choice for solopreneur businesses since it is the dominant choice for small and medium businesses throughout America, and it has a large user base and support network.
However, Wave and other online bookkeeping tools have grown in popularity for freelancers who want to be able to accept payments and not have to do additional work to send invoices and record transactions. Most of these solutions offer pre-built charts of accounts for freelancers and small service businesses that do not have inventory or employees, which creates additional complexity and a need for more regular bookkeeping. Simple transactions and low volume help keep independent contractors from having too many headaches in setting up their bookkeeping system.
Essentially, it needs to account for the different types of revenue received. Service revenue should be broken down by the type, such as a self-employed attorney who does a mix of legal consulting for their own clients, overflow contract work with larger law firms, and also gets paid to write legal articles. This not only helps determine where most of your income is coming from, but what types of engagements you should focus on.
Many independent contractors who work on their own projects like blogs and apps can also receive different types of income separate from performing services, like sponsorship, advertising and affiliate income, and royalties generated from pageviews or the sale of products like e-courses and apps. This income should be booked separately of service revenue, particularly if earning passive income from your own work is a goal.
Most independent contractors and freelancers do not have large sums of money tied up in equipment and vehicles, the way that a traditional brick-and-mortar business is apt to. Thus, fixed asset and depreciation accounts are usually not necessary unless you invest a great deal in a robust computer system. However, expense accounts need to be set up for the common types of expenses that you are likely to incur. This would include website expenses, running ad campaigns if you are selling your services or digital products, bank charges, and research (writers who get paid to write about TV and movies need to account for their Netflix subscriptions, for instance).
Bookkeeping for independent contractors, freelancers, and gig workers isn’t as intimidating as it looks. Once your basic infrastructure for it has been set up, it becomes easier to use and maintain over time. In addition to helping you keep track of your income and expenses for tax reporting purposes, accurate and up to date books are incredibly important if you’d like to get financing for your own projects. If you are planning on going from a freelancer to having your own full-blown digital business, it’s crucial to have the appropriate business and tax framework in place: the foundation is solid bookkeeping.
One challenge that many independent contractors and gig workers face is that there’s more likelihood of business and personal expenses crossing over, in comparison to other types of business that are likely to have designated devices, vehicles, and real estate solely for business use. It is highly recommended that a bookkeeping system is set up after separate bank and digital payment processor accounts have been opened so that as many expenses as possible can be separated. For the ones that can’t, such as claiming use of a home office, some of these transactions will be calculated separately on your tax return instead of put on the books. Others can be partially put in the books if they used the separate accounts mentioned, or split between personal and business accounts. Since gig work tends to not have this infrastructure set up for it, having tools like QuickBooks Self-Employed makes it easier to go through mixed-use accounts and isolate allowable expenses.
Disclaimer: Please keep in mind that the content of this post is not intended as tax, accounting or legal advice. The information presented here is for informational and educational purposes only. Before engaging in any transaction, be sure to discuss these matters with a trained, licensed professional.