Some people go into business for themselves so they can call their own shots; others turn to self-employment out of necessity after falling victim to today's chronic high unemployment rates. Whatever your reason, it pays to know the potential risks involved -- in addition to the rewards -- before hanging out your shingle.
First, recognize that as the boss you're now accountable for many critical responsibilities your employer once managed on your behalf, such as providing insurance, deducting money from your pay for taxes and maintaining your retirement account. A good portion of your time will now be consumed by these tasks; or, you'll have to pay someone else to do them for you. Ignore these responsibilities and your future financial security could be at risk.
Health Insurance. This should be one of your top priorities. Health insurance is expensive, especially if you're not part of a group plan, but going without it is extremely risky: More than half of all personal bankruptcies result from high medical bills. The good news is that monthly premiums are fully deductible, which considerably lowers your taxable income.Consider these options:
- Coverage through your spouse's plan or a trade or professional organization to which you belong.
- COBRA continuation coverage through your former employer. Double-check eligibility requirements and enrollment deadlines. If you were involuntarily terminated before June 1, 2010, and have already taken advantage of the government-provided 65 percent COBRA premium reduction you may continue to pay reduced premiums for up to 15 months as long as you're not eligible for another group plan or Medicare. Rules are complicated, so read this Fact Sheet from the Department of Labor for details.
- An insurance broker can help you find appropriate private coverage -- try the National Association of Health Underwriters if you don't know one. But be aware that even minor preexisting conditions may render you ineligible.
- High-deductible plans provide comprehensive coverage for catastrophic illnesses that could otherwise deplete your savings, but their monthly premiums are considerably cheaper than comparable low-deductible plans.
- Many states provide high-risk insurance for people who don't qualify for private insurance. It's costly, but no one can be turned away. Visit www.naschip.org for information.
- Health Insurance Portability and Accountability Act (HIPAA) insurance may provide coverage if your COBRA has expired and you don't qualify for private insurance. Eligibility rules are very complicated so consult a knowledgeable insurance broker.
Tax Implications. Calculating and filing taxes is often more complicated for self-employed people and good recordkeeping is essential. Unless you're an accounting whiz, consider hiring a tax professional or financial planner who specializes in self-employment issues. The penalties and fees they can help you avoid -- and hidden deductions they can uncover -- will probably more than pay for their fees.A few tax considerations:
- You can generally deduct many business-related expenses, including: legal and accounting fees; home office (including a portion of utilities and rent); professional dues and subscriptions; business insurance and licenses; professional training and education; professional equipment and software; maintenance/repairs; and business-related travel and entertainment. For more details, see IRS Publication 535.
- You are responsible for paying 15.3 percent of net earnings in self-employment tax. Of this, 12.4 percent goes to Social Security and 2.9 percent to Medicare. Regular employers split this cost 50-50 with employees (otherwise known as "FICA"). However, you do get to reduce your taxable income by that same 7.65 percent before calculating your self-employment tax; and then claim one-half of the tax as a deduction.
- For more details, visit the IRS's Self-Employed Individuals Tax Center.
Saving for retirement. Because you won't be earning employer-provided pension or 401(k) benefits, you must manage your own retirement savings strategy. Fortunately, you have many options, including regular and Roth IRAs (to which you may contribute up to $5,000 a year, or $6,000 if over 50), and Simplified Employee Pension (SEP) IRAs, which let you save even more -- up to 25 percent of pay in many cases.A few other self-employment pointers:
- The Small Business Administration offers numerous online training courses and publications, as well as local seminars and classes on a variety of topics, such as applying for SBA loans, accounting, writing a business plan, marketing yourself, and much more.
- Many accounting software packages are available to help you track income and expenses, billing, tax filing deadlines and more, including QuickBooks, Sage Peachtree and AccountEdge. Besides simplifying your bookkeeping, using such software also helps reduce your tax preparer's charges because the information you provide will be better organized.
- Make sure you have adequate liability insurance. Many homeowners and renters insurance policies don't cover home business losses so you may need a separate policy.
- Invest in good equipment, but don't go overboard until you know your needs. Renting or leasing equipment initially may make sense; and, you can deduct those costs as business expenses.
- If your business is computer-based, make sure your software is compatible with what your clients use. And find a good computer technician ahead of time, in case your system crashes.
Working for yourself can be extremely satisfying -- just be sure to anticipate potential pitfalls before taking the plunge.
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.
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