When you work for an employer, tax is taken before you see your pay. When you work for yourself, nobody does it for you. The money in your account is not all yours, and the most common mistake freelancers make is to spend it as though it were.
Why the money is not all yours
Self-employed people usually pay income tax on their profit and a form of social insurance, such as National Insurance in the UK or self-employment tax in the US. In many places the bills arrive months after the money has been earned, in lump sums or quarterly instalments. If you have spent the money, the bill is a shock.
A simple holding habit
Open a separate savings account and move a fixed share of every payment into it as soon as it arrives. A common starting point is 25 to 30 percent of your profit, but the right share depends on your income and country. Use our calculators to estimate the tax on an employee's pay of the same amount, then add something for the extra social insurance that self-employed people often pay.
Work out what you can really spend
Your income is what you charge minus your business costs, and your spendable income is what is left after the tax pot. Subtract your costs first, then set aside tax, then pay yourself. This is also how to decide whether your prices are high enough. Our sister site has a free Freelance Rate Calculator at invoicetemplatesonline.com that works backwards from the take-home income you want to the rate you need to charge.
Keep your records
Keep every invoice and every receipt for business costs, in one place, from the first day. Record the date, the amount and what it was for. It makes your tax return quick and may reduce your tax by capturing costs you would otherwise forget. Accounting software helps, but a simple spreadsheet is enough to begin with.
Remember the other things employees get
Employees usually have paid holiday, sick pay and an employer pension contribution. Freelancers have to pay for those themselves, by setting aside time and money. When you set your rate, include a share for unpaid days, slow months, insurance and your own retirement saving.
Get advice early
Rules for the self-employed vary widely and change often. A short session with an accountant in your first year is usually worth the cost, and it can set up a system you will use for years. Our calculators are for employees and give estimates, not advice.
Calculators for this guide
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- Marginal and Effective Tax Rates: Why a Pay Rise Never Costs You Money
- Retirement Contributions and Take-Home Pay: Before Tax or After?
- How to Compare Two Job Offers Properly
- Why Your Real Payslip May Differ From an Online Estimate
- Bonuses and Overtime: Why They Seem to Be Taxed More
- How to Build a Budget From Your Take-Home Pay
- States With No Income Tax: What That Does and Does Not Mean
- Moving for a Job: Will You Really Be Better Off?
- Asking for a Raise: Using Take-Home Numbers to Plan the Conversation
- Student Loan Repayments and Your Take-Home Pay
- A Yearly Tax Check-Up in Thirty Minutes
- All tips and guides
These guides are general information and estimates to help you plan. They are not tax advice. Rules and rates change, so check the official tax authority for your country.