I say “probably making,” because these are all mistakes that I’ve made along the freelance path–hopefully this post will save you from repeating them! Of course, everyone is at a different stage of freelance financial management; if you answer no, no, and no to these…great. That means you can focus on doing what you actually do for work, not worrying about money. But if you do need some help, read on!
Mistake 1: Not separating your business and personal finances
If you make one change to your freelance finances after reading this post, I literally beg you to choose this one. Where do I start…commingled finances are a rat’s nest of problems…a rat’s nest that you’ll be stuck untangling if/when you are audited by the IRS. Was that ream of paper for business or personal use? How about the lunch? The postage? Things get really messy when you only have one set of accounts. I’ve talked to freelancers who don’t even have a clear record of what they earned, because they look at their bank statement and don’t know if that $75 deposit was from a client, or from a personal friend who owed them money for something. Stop the insanity and (completely) separate your business and personal finances.
Do this: Open a separate set of accounts for your business. Even if you are a sole proprietor, just get a separate checking and savings account in your own name. This also frees you from saving receipts (say goodbye to your shoebox of barely-readable thermoprinted receipts) unless you pay cash for a business expense. Simply use the debit card associated with your business account to pay for all business expenses, and you have them in one place. Which brings us to…
Mistake 2: Not having a business savings account
In my experience, very few freelancers have a business savings account; they just deposit everything into one big bucket–their business checking account. I did this too, for about the first 10 years of my freelance career. Problems here: Most critically, you can end up without enough money to pay your taxes, especially if you unexpectedly earn more than you expected to.
A business savings account also allows you to create a paid vacation fund by depositing a set amount of money every week/month/quarter, then using that to pay yourself when you’re not working. You can also use a business savings account as a rainy day fund, in the event that your computer dies–which also happened to me–or you get sick and can’t work for a few weeks, and so on.
Do this: Best option, open a separate account. Second best, create a partition or earmark in your business checking account. Then, designate a certain percentage (I do one-third) of each client payment and put it in that account. Most importantly, do not touch it except for its designated purpose. The designated purpose can be, “Break glass in case of emergency.” I did that this year, when I planned to work for part of the month that my family spent in British Columbia, then decided that life’s too short and I didn’t want to work. Instead, I drew money out of my business savings account to pay myself. At the very least, do not get caught short at tax time: sock that money away in a business savings account.
Mistake 3: Underestimating how much you need to earn
This is a big one for many freelancers–in fact, I wrote a whole post about it. Lots of freelancers calculate their target income like this: “My last salaried job paid $72,000 a year. So if I work 40 hours a week, 50 weeks a year, that’s 2,000 billable hours, so to make $72,000, I need to make $37.50 an hour. That doesn’t sound hard at all!” I’m exaggerating here, but only a little. Don’t forget that as a freelancer, you:
- Won’t, and perhaps shouldn’t even try to bill 40 hours a week. You have accounting, marketing, issuing quotes to potential clients, keeping up to date in your specializations, learning new software, attending conferences and webinars, and so on. Trying to bill 40 hours a week as a translator is a recipe for burnout. Let alone the fact that many beginning translators have periods when they would like to be working but have no work.
- Have many expenses that a salaried person does not have. US self-employment tax is a pretty big hit at 15%; translators in Europe probably pay even more. Then there’s health insurance, which can be a very big hit if you live in the US. Then there’s paid vacation, retirement, computer equipment, continuing education, work-related travel, professional association dues, and so on. All of that is on you.
- Are much more at risk than a salaried person if you get sick or injured and can’t work. Some translators carry disability or loss-of-income insurance, but most–in my experience–do not. Even something as benign as a sprained wrist, and certainly something critical like cancer, or a heart attack, or a very sick child who needs full-time care, can put you in a serious financial pinch.
Do this: Be honest with yourself about how much you need to earn in order to achieve a similar level of financial security to someone with a traditional job. Or, in 2018, maybe we should say someone with a traditional job at a place that treats its employees well. Not only do you deserve that, you need to put those safeguards in place if you want freelancing to be your “forever” job.
Mistake 4: Not incorporating when it would make sense to incorporate
Here I’ll talk about the US system, but I think many European countries operate in a similar way. Incorporating involves some paperwork, some hassle, and potentially some money in the form of filing fees and/or payroll and end-of-year tax returns. This varies by state; check your state’s Secretary of State website for information.
At a certain income level, incorporating can save you a bunch of money by allowing you to (legally) avoid paying self-employment tax on a portion of your income. Even one-person corporations to legally draw some money out of the company as “wages” (which are subject to self-employment tax) and some as “corporate profit” (which is not subject to self-employment tax. In my case, I pay my accountant to do my S Corp’s quarterly payroll taxes and end-of year tax return. That costs me about $1,000 a year, but I would estimate that even with that expense, I still save over $4,000 in self-employment tax because of the S Corp. The question is when it’s worth it to incorporate: I’ve heard $40,000 gross income, $50,000 gross income…it kind of depends. Talk to an accountant.
Do this: Talk to a knowledgeable accountant about whether you should incorporate, and if so, as what type of entity. A couple of pieces of advice here: if you use an accountant to prepare your business taxes, use someone who is an IRS Enrolled Agent (EA). This means that they can interact with the IRS on your behalf, and you should rarely, if ever, have to personally deal with the IRS. Also, note that the method I described above (wages versus corporate profit) can have some broader repercussions. First, your wages are a lot lower than your gross revenue, which makes you look as if you earn less money than you actually do–perhaps not the greatest option if you want to apply for a mortgage or other type of loan. Second, this may affect your level of Social Security benefits; if you are close to retirement or if you see Social Security as a major source of your retirement income, make sure you understand what you’re doing here.
Readers, over to you!! What’s a financial mistake you’d like to help other freelancers avoid??
Hi Corinne. Thank you for another great post.
Best regards!
Juan
Glad you enjoyed it, thanks for your comment!
Excellent post Corinne, with a lot of jewels for people getting into the business. I could only add the pro’s and con’s of working overseas like me:
For one thing, you can avoid (most) US income tax if you do decide to work overseas. BUT: you CANNOT avoid self-employment tax regardless of where you live, so you need to discuss the issue with an accountant before you make your move.
Secondly, you need to find out the rules where you intend to live. Countries here in SE Asia, where I live, will not normally tax you on income from foreign sources (e.g., you live in Malaysia and you are paid by a client in New York or Paris), even if you have the money paid into an account here. However, European countries are not likely to take the same lenient attitude toward it. In fact, working in Europe in general may create problems for you if you don’t have the right visa. And having the right visa may mean that you have to have a visa allowing employment – which means taxes. Of course, this consideration needs to be offset by the fact that in Europe paying taxes should allow you to enroll in the national health scheme, which will take a large chunk of your income if you live in the US.
Some other countries (like Thailand, for example) may revoke your visa if the government thinks that you are taking viable employment away from a citizen. Still others, like much of Latin America, expect you to become a “resident” if you intend to spend more than six months a year in country – in fact, many insist on it. The significance of residency? Simple: your income is taxable.
Thanks for your comment; that’s really interesting about the overseas aspects, thanks for bringing it up! It does seem that different countries take very different attitudes: i.e. some are concerned with collecting taxes from expats (for example my understanding is that it’s very difficult for non-citizens to be self-employed in Switzerland, for that very reason), while others are concerned with whether the expat is taking a job away from a citizen. Thanks for those varied and very interesting examples!
Interesting post, thank you, Corinne, although I must admit that I groaned when I saw the reference to business savings accounts. I don’t know what the situation is in the US, but in the UK business savings accounts, as far as I can see, are a complete joke: they make the rates paid to personal savers look very generous! For example, one of the banks here is offering 0.2%, and I think that’s quite generous – I think I’ve seen 0.05% recently. One of the benefits of being a sole trader is indeed that I can operate off a personal bank account and put the money into a personal savings account.
Thanks, Alison! That’s interesting: here in the US, savings accounts (of any flavor!) earn such little interest that it’s not really a factor. I’m not aware of a difference between business and personal savings accounts but now I will check that out!
Yeah, those savings accounts that you can access at any time really don’t have great interest rates. Mine has 0.15% (in the Czech Republic). But it is really more about having that money for taxes and “break glass in case of an emergency” situation. So it’s still better than nothing.
Corinne, great article! Been preaching the same for years, aside from your No. 4. Wouldn’t have made any sense while I was in Germany (totally different tax system). Now, in the Czech Republic, I haven’t quite wrapped my head around the system, but I am far from reaching any thresholds. Still working only 30 to 40% because of our baby girl. However, in January, my partner (also a translator) started a limited liability company for the reasons you outlined, even if the details are a bit different. So he no longer freelances.
The only thing I’d add-for those who are really new in the profession or even only considering a career in translation-that starting out as a freelance translator does not cost nothing. I’d say one should have at least two years of expenses covered, including personal expenses, such as rent/mortage, groceries, clothes, etc. and of course business expenses, such as fees, dues, software, training, etc. I heard young people say so often that all they needed was a laptop and a WiFi connection. Uhm, nope. Doesn’t work like that. At least not if you don’t want to be working Fiverr gigs 50 hours a week. That’s not building a career, that’s exploiting yourself and setting yourself up for a proper burnout.
Thanks, Tanya! That is such a great point about freelancing not having zero startup costs; many translators overlook that!
Thanks for this, Corinne. I’m glad you added the bit about not paying into Social Security lowering your final income from Social Security. I was incorporated (before going into translation) with another business and suddenly realized I was going to get close to zilch for SS when I retired, so hired myself and at least paid myself a minimum salary. Yes, it adds bookkeeping etc., but in my case, having worked overseas and as a teacher in a state where teachers don’t pay SS, I needed to grow my entitlement to SS. I’m now of the age where I’m looking how much that check will be, and I’m very glad I caught that problem when I did. And now that I’m a sole proprietor as a translator, I pay SS on my entire net income for that very same reason. Yes, I’ll get some SS from Germany and from Switzerland, but it still won’t add up to what the SSA claims is the customary amount people get when they retire who have worked their entire lives in the US. Of course, I have other sources too, but at this point the government (SSA) looks more reliable to me than the stock market for the next 30 some years. I don’t believe all the bunk that the SSA will go broke!
Thanks, Ruth!! That’s a really interesting example of how that all shakes out. I agree that, say, 10-15 years ago, the conventional wisdom was that those of us born in the 70s or later would get close to zero because Social Security would go bankrupt, which doesn’t seem to be the case. I’m 46 and used to assume that I would get nothing from SS, whereas now I think it could be modest but helpful. So it’s definitely worth looking into; glad you caught that in your business!