Common Mistakes and How to Avoid Them
The transition from employee to independent contractor can be tricky. Many new gig workers make the same honest mistakes. Being aware of these common pitfalls can save you significant time, money, and stress.
Mistake 1: Forgetting About Self-Employment Tax
This is, by far, the most common and costly mistake. Many people are thrilled to receive a check from a client for the full amount, without any taxes taken out. They forget that a large portion of that money—15.3% right off the top of their net profit—is owed to the government for Social Security and Medicare. Then, when tax time comes, they are hit with a surprisingly large bill they haven’t budgeted for.
How to Avoid It: From the very first dollar you earn, get into the habit of setting aside a percentage of your profit in a separate savings account. A conservative starting point is 30%. This “tax savings” account should be treated as untouchable for any other purpose. It ensures the money is there when you need to make your quarterly estimated payments or settle up on April 15.
Mistake 2: Failing to Pay Estimated Taxes
Many new entrepreneurs assume they can just pay all their taxes in one lump sum when they file their annual return. However, the IRS expects you to pay as you go. If you wait until the end of the year and owe a significant amount, you will likely be charged an underpayment penalty plus interest.
How to Avoid It: Mark the four quarterly tax due dates on your calendar: April 15, June 15, September 15, and January 15. After each quarter, calculate your net income for that period, estimate the tax you owe on it, and make a payment to the IRS. Even if you can’t pay the full amount, paying something is always better than paying nothing. It reduces the potential penalties.
Mistake 3: Mixing Business and Personal Finances
Using your personal checking account and credit card for business activities is a recipe for disaster. It makes bookkeeping incredibly difficult and time-consuming. You’re more likely to miss deductible expenses and, in the event of an audit, it can make it harder to prove that your claimed business expenses were legitimate.
How to Avoid It: As mentioned earlier, open a separate bank account for your business from day one. All business income goes in, and all business expenses go out. This creates a clean, simple, and defensible record of your business finances.
Mistake 4: Not Tracking All Deductible Expenses
Every dollar you spend on a legitimate business expense reduces your taxable profit. Failing to track these expenses means you are voluntarily paying more in taxes than you are legally required to. Many gig workers forget to track small cash purchases or don’t bother logging their business mileage.
How to Avoid It: Be meticulous. Get a receipt for every business purchase, no matter how small. Use a mileage tracking app on your phone or keep a physical log in your car. At the end of each month, review your business bank and credit card statements to ensure you’ve captured every deductible expense in your record-keeping system.
Mistake 5: Misunderstanding the Impact on Social Security Benefits
This is a particularly crucial mistake for retirees. Starting gig work without understanding how the earnings might affect your Social Security check can lead to an unwelcome surprise when your benefit amount is reduced or you get a notice saying you were overpaid and must pay it back.
How to Avoid It: Know your Full Retirement Age (FRA). Before you start working, visit the Social Security Administration’s website or call them to understand the exact earnings limit for your age group for the current year. If you are under your FRA, carefully track your earnings to stay under the limit or be prepared for the temporary benefit reduction. Remember that once you reach your FRA, this limit no longer applies.
Mistake 6: Assuming You Have Employee Protections
As an independent contractor, you lose the legal safety net that protects traditional employees. You are not entitled to minimum wage, overtime pay, unemployment benefits if your contract ends, or workers’ compensation if you are injured on the job. You are also not protected by most workplace discrimination and harassment laws.
How to Avoid It: Understand that you are a business owner. This means you are responsible for your own safety net. You need to budget for your own “paid time off,” save for retirement independently, and consider purchasing private disability or liability insurance depending on the nature of your work. Read your contracts carefully before signing them to understand the terms of the agreement. For more information on consumer and worker rights, you can consult reliable sources like Federal Trade Commission (FTC).
