Apples to Apples: Comparing Self-Employed Income to Traditional Wages

In traditional employment, especially if you're making a change from one job to another, it's critical to understand how to compare "apples to apples."

For example, a friend of mine was making about $43,000 working from home and got an offer at another company for $53,000. That's a ten thousand dollar raise! But it's not so simple. Because the new job also came with at least two hours of commuting each day, which is a big hit to work-life balance (as well as an increase in car maintenance costs).

After factoring in the commute, my friend decided to go ahead with the move because the rest of the pros and cons leaned toward the new gig. However, the "100% employer covered" insurance that was such a perk on the pro-con list actually has a massive deductible, so now my friend is paying $150 a month for the meds that were covered entirely by their old plan.

Technically, they're still a few thousand dollars ahead of where they used to be... but the ick is strong.

We can't always know how things will work out in advance. But one or two experiences like this should teach you to make sure you're looking at the most accurate side-by-side comparison when you're choosing between two options.

One of the most easily-understood but also easily-avoided mistakes you can make when starting a small business is treating your self-employed earnings the same way you treat your paychecks.

The major difference: your gross revenue has not been taxed yet, and you still owe the government its cut.

Don't go spending it all in one place. At least, not until you've made sure you're actually comparing net income to net income.

We're used to seeing a net earnings paycheck with all the necessary deductions taken out to pay for health insurance, 401(k) savings, and tax withholdings. When you go from making wages to owning your own business, you need to take care of these "off the top" expenses yourself.

The first month I made $10K I splurged on a lot of goodies to celebrate, including a frugal vacation to visit a friend across the country, getting my hair done professionally for the first time in a long time, and buying myself a pretty ring from a creator on Etsy.

The first couple years I was self-employed, my taxes weren't that big a thing. I could pretty much wing it without having a huge bill at tax time. But that year with the $10K month had much more profit than I was used to, and I am still paying off the IRS.

So allow me to tell you a cautionary tale - handle your taxes BEFORE celebrating your new highest revenue month.

Small business owners should pay quarterly estimated tax payments to stay on top of the amount they'll owe in April. Putting this off to the last minute not only results in a large tax bill but can also hit you with major penalties for failure to pre-pay.

You may also need to pay estimates to your state and city, depending on your location.

In general, we recommend setting aside about 30% of your revenue for taxes. This percentage has some wiggle room depending on your business expenses, since your overall tax will be based on your overall profit.

Say you make $5,000 gross revenue per month and set aside $1500 (an even 30%) for your taxes. This assumes that your gross revenue is effectively profit, and it usually isn't. There are expenses to account for, like advertising, paying contractors, purchasing supplies or software, miles driven, utilities, etc.

If you have a solid grasp on your expenses, you may be able to set aside a smaller percentage for taxes. For instance, you make $5,000 gross revenue but after expenses you net about $3800, of which 30% is only $1140. In the early days when you're probably running as scrappy as possible, this few hundred bucks could make a big difference by staying in your pocket.

When in doubt, check with a professional.

Your state may collect Sales and Use Tax on some (but not necessarily all) products and/or services, so it's worth checking in with your state's government website for the most up to date instruction on paying sales tax. In Ohio, sales tax is due monthly, and it's best practice to keep the state paid on time, in full.

Taxable items may include clothing, personal care items, electronics, household products, medical equipment, fitness and sporting goods, pet supplies, hobby supplies, toys, books and magazines, and other goods.

Services subject to sales and use tax may include maintenance services like pest control, car detailing, landscaping, and other installation/repair; cleaning and laundry services; catering; personal care services such as spa services, tanning, cosmetics, tattoos, and piercings; lodging and short-term rentals; private investigation; and select other services.

It's possible to manage your business expenses, including taxes, on your own. But if you aren't certain you've got the know-how to keep yourself on the government's good side, hiring a pro is always a smart move.

At Tree City Tax Service, we offer tax prep and advising, as well as bookkeeping support for small businesses. And if your business falls outside of our scope, we have a friendly referral network available to make sure you get the support you need.