Some people go into business for themselves so they can call their own shots; others turn to self-employment after falling victim to today's chronic unemployment rates. But before hanging out your shingle, recognize that you'll be responsible for many things your employer once managed, such as providing insurance, payroll deductions to pay taxes and maintaining your retirement account. You'll either have to spend time on these tasks or pay someone else to do them.
Don't ignore these financial responsibilities:
Health insurance is expensive, but going without is extremely risky: More than half of personal bankruptcies result from high medical bills. Fortunately, 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.
- COBRA continuation coverage through your former employer. Double-check eligibility requirements and enrollment deadlines.
- An insurance broker can help you find appropriate private coverage. (Be aware that preexisting conditions may render you ineligible.)
- High-deductible plans provide comprehensive coverage for catastrophic illnesses at much lower cost than comparable low-deductible plans.
- Many states provide high-risk insurance if you don't qualify for private insurance. Visit www.naschip.org for information. Or, investigate Health Insurance Portability and Accountability Act (HIPAA) insurance after your COBRA expires. Eligibility rules are very complicated so consult a knowledgeable insurance broker.
Calculating and filing taxes is often more complicated for self-employed people. Unless you're an accounting whiz, consider hiring a tax professional who specializes in self-employment issues. The penalties and fees they help clients avoid – and deductions they can uncover – usually more than cover 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; training and education; and business-related travel and entertainment. See IRS Publication 535 at www.irs.gov for details.
- You must pay 15.3 percent of net earnings in self-employment tax (for Social Security and Medicare). However, you can reduce your taxable income by 7.65 percent before calculating your self-employment tax; and then claim one-half of the tax as a deduction.
- Visit the IRS's Self-Employed Individuals Tax Center for details.
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 (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.
A few other self-employment pointers:
- The Small Business Administration (www.sba.gov) offers numerous online training courses and publications, plus local classes on many topics including applying for SBA loans, accounting, writing a business plan, marketing yourself and more.
- 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.
- 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.