How you look at your earnings when you’re a free-wheeling freelancer is the opposite of how you look at them when you’re a W2 employee. When you have a regular paycheck, you take that amount and work out what you can afford from there; think of that as the top-down approach. That paycheck even determines how much rent or mortgage you qualify for, so you have some built-in limits right there. But when you’re self-employed, it’s more of a bottom-up approach – you have to know what you need to earn in order to pay your bills, and then bust your ass making sure you don’t come up short. But figuring out your magic number is not as straightforward this way. Lucky for you, I love math 🙂
Most people are in touch with their monthly spending on necessities like the roof over their head, utilities, health insurance, food and all that. What we tend to forget are the quarterly or annual expenses, and those need to be pro-rated into your monthly earning needs. So make a list of those, put the annual total regardless of their frequency, divide it by 12 and add that to your monthly number. Here’s a list of possible non-monthly regular expenses to help trigger your memory of these things…because yeah, it’s way too easy to forget some of these things.
If you’ve been “pantsing” it (a cute shortening of “flying by the seat of your pants” that I’ve recently come across, hehe), then you might feel a little sinking feeling after being reminded of these items. Just remember, all those numbers get divided by 12 before it gets added to your monthly number. I hope that total doesn’t make you sweat, because there’s more…
If you want a no-fuss number to work with, add about 40% to that number right there. From that larger number you’ll pay 15%-ish in the oddly-named “self-employment tax” (both the employer’s and employee’s portions of social security), and then about 20% on the rest…works well enough for earning in the $30-80K range. If you hate numbers but really really hate the prospect of a shocking tax bill, this should keep you on an even keel.
Remember to pay it quarterly, though I’m only just getting the hang of that myself. Sometimes it’s just easier to pay the interest penalty and do it once a year, but it can be a painful check to write. Of course if you think you’ll be tempted to use the money set aside for other purposes, definitely go with the official way and pay it quarterly!
Well, that’s not a no-fuss number. It’s kind of annoying, truth be told, unless you’re really anal about spreadsheets and keeping everything super up-to-date. As much as I love personal finance and knowing where I stand, record-keeping isn’t something I love doing. So I ballpark the expenses and work with a minimum number because my goal is to avoid a financial shock. It’s good to have goals – especially this one!
The write-offs you really want to concern yourself with are the ones that are part of your existing expenses and have a fairly similar value each month. Here’s where you should focus to find your minimum monthly level of deductions that are totally legitimate – the famous “perks of self-employment” we’ve all heard about. Now I’m not an accountant nor do I play one on TV, so with all of the items below, check the current rules about how to determine what portion is deductible.
So how do you apply this to knowing your numbers? Well it only changes how much you put aside for taxes – by making your estimate more accurate. Take your pre-tax “Must Earn” monthly number (monthly expenses plus 1/12 of your non-monthly expenses) and subtract the above deductible items. Then add 40-50% of that reduced number to your pre-tax “Must Earn” monthly number – and THAT is what you must make on a monthly basis to keep afloat in a barebones (ie no vacations) way.
Monthly + 1/12 of non-monthly expenses, pre-tax: $3000
Deductible portion of above-listed biz expenses: $600
Ballpark taxable income: $3000-$600 = $2400
Easy way, no deductible expenses: 40% of $3000 = $1200, so you must earn $3000 + $1200 = $4200
Some effort, some deductible expenses: 40% of $2400 = $960, so you must earn $3000 + $960 = $3960
Also remember that every additional dollar you spend on your business must be earned beyond your total Must Earn number – supplies, travel, courses, entertainment/meals, tools/apps, subscriptions, etc. All of these items would then be added to what you need to earn that month… though ideally you’re spending the previous month’s profit and not adding pressure to the current month!