Self-Employment Poses Particular Finance Challenges

Do you dream of just chucking the corporate rat race and becoming your own boss?

Many workers have chosen that option after joining the ranks of the millions who have lost their jobs in the recession.

While there's a certain amount of freedom at being your own boss, there's also the realization that you now wear two hats — employer and employee.

That means you must be extra vigilant about how you manage your finances because your personal money and business money are closely intertwined.

"When you're starting your own business, they are almost one and the same," said Ken Sibley, certified public accountant and founder of Sibley & Co., a Dallas accounting and business consulting firm.

More and more people are dealing with this situation. An average 8.6 percent of unemployed workers started their own business in 2009, up from an average 5.1 percent in 2008, according to Challenger, Gray & Christmas Inc., a global outplacement consulting firm.

"Rather than endure several more months of unemployment, as employers slowly move toward renewed hiring, many job seekers are opting to exit the labor pool and start their own firms," said John Challenger, chief executive of the Chicago-based firm.

Those working for themselves must divvy up their money very carefully.

"You should know without hesitation what the minimum amount of money you need every month to maintain your life and your business," said Denise Kiernan, co-author with her husband of "The Money Book for Freelancers, Part-Timers, and the Self-Employed."

"You have to commit to tracking both your income and your spending very vigilantly," she said. "You need to understand where your money's going."

That's how young entrepreneur Jeff Livney did it and still does.

Livney, 21, started Livney + Partners, an interactive advertising firm in Fort Worth, Texas,, when he was still in high school. He'll graduate in May with a degree in entrepreneurial management and marketing from Texas Christian University.

"One of the biggest things is going to be determining how you can bootstrap and live off of your current savings and how much debt you're willing to take on," said Livney, who started out with no debt. "Most businesses are not cash-flow-positive in the first few months."

When he started out, Livney didn't eat out as often or go to the movies as often. He's also kept his business and personal expenses separate.

Not commingling those two is important, said Jim Smith, certified public accountant and managing partner at Smith, Jackson, Boyer & Bovard PLLC in Dallas.

"We recommend to people that if they want to start their own freelance business, that they consider getting a separate checking account and a separate credit card account," he said.

If business and personal expenses are too closely intertwined, it can be difficult for a business owner to justify business expenses claimed on an income tax return "because things are so closely mixed up," Smith said.

That's especially true for claiming a deduction for a home office, which the Internal Revenue Service examines closely.

It must be an office solely dedicated to your business. Don't have toys lying all around and don't use it as a spare playroom for your children.

"The IRS has the right to come into your home to verify the existence of the office and the expenses you're claiming," Smith said. "I have actually had the IRS audit clients and insist on physically examining the (home) office."

Income taxes are a principal reason that independent workers need to have money saved because you must pay employer taxes as well as personal income tax.

You have to worry about making estimated tax payments, which is how the self-employed pay tax on income that is not subject to withholding from a paycheck.

The estimated tax is used to pay income tax and the self-employment tax, as well as other taxes and amounts reported on your tax return. The self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves.

If you don't pay enough through estimated tax payments, you may be charged a penalty.

And if you don't pay enough by the due date of each payment, you may be charged a penalty even if you're due a refund when you file your tax return.

After taxes, health insurance is your next biggest worry.

If you've been laid off, you may still be paying for health insurance on your former employer's plan through COBRA, which allows many laid-off workers to remain on an employer's group health plan for 18 months.

Livney's case is unique because of his young age. He has been on his parents' health insurance plan, but that will end at the end of the year.

He plans to buy a small-business health insurance plan, which will cover him, his company's only employee.

"There is an added level of complexity once you become self-employed," said Bragg Comer, a certified financial planner in Rockwall. "You have to be more defensive of financial planning going forward."

If you're not prepared for self-employment, financial management can be jarring.

"If you have been making a salary and you wind up self-employed," Smith said, "the question you've got to figure out is, 'How fast am I going to start making money?' "

SOURCE: The Dallas Morning News. Distributed by McClatchy-Tribune Information Services (c) 2010.