Freelance Finance Master Class: Put Yourself on Payroll to Save on Taxes

By Chelsea Baldwin, Contributor, on February 5, 2018

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I know, I know. You left the 9-to-5 world and became a freelancer so you wouldn’t have to deal with terms like “payroll,” “accounts” and “salary” ever again. Freelance finance all the way, baby — which meant things would be simpler.

And I have to say: I don’t blame you. It was sweet, sweet freedom when I realized I could just go ahead and make a business investment without having to go through five departments’ worth of red tape and meetings. I swore up and down that I was becoming a freelancer so I could have my freedom, and that meant no traditional business-as-usual in my book.

But then I found out that I was paying thousands of dollars more in taxes than I had to every year. And I realized that if I bit the bullet and put myself on payroll, I’d actually have a lot more money in my bank account … which is exactly what I wanted.

Putting Yourself on Payroll Is Not That Scary

I get it. Doing something like this sounds scary. If you don’t know how much you’re going to be making each month, how can you commit to a monthly salary amount? What if your monthly salary is too much and you can’t pay your business bills during the summer? Or what if you earn more than you were expecting, but can’t benefit from the money because you’re not allowed to pay it to yourself as a bonus?

But the thing is: Putting yourself on payroll doesn’t have to mean any of that.

Actually, when you have a payroll specialist set it up for you, you can keep transferring money from your business account to your personal account as you need it, and let them figure out your salary amounts for the year and each quarter. See? It’s not as stressful or difficult as you may think.

For the most part, it’s business as usual … until tax time comes around and you’re paying thousands of dollars less than you did last year.

The Nitty-Gritty: How It All Works

I know you’re probably feeling really skeptical right now — and wondering if I’m giving you advice that’ll end up in an IRS audit. But I swear I’m not.

So here’s the breakdown of how it all works:

  • If you’ve got an LLC (and you should, to protect your personal assets), you can retroactively list it as an S Corp for the entire fiscal year you’re working with. Do this through your accountant.
  • Once your S Corp status is approved by the state, you’ll need to work with a payroll specialist to set up your payroll. Make sure it’s someone your accountant likes to work with, because they’ll have to figure out your quarterly estimates together.
  • Be open about your numbers from quarter-to-quarter with your accountant and your payroll specialist. When the time comes to pay quarterly payroll taxes, they’ll figure out which percentage to count as wages and which part to count as dividends. Then they’ll send you a notification for how much they’ll draft from your bank account to pay the tax for you.

That’s really all there is to it. And this is how it saves you money:

  • When your LLC becomes an S Corp, you become a shareholder and an employee.
  • As an employee, you get a salary that you pay income tax on. Your company pays payroll tax for you.
  • As a shareholder, you qualify for company profit dividends that are untaxed. Yes, you get tax-free dividends.
  • Your accountant and payroll specialist will figure out which percentage of the money you pay yourself is your salary and which percentage is your dividends. While this depends on your situation and your accountant’s preferences, sometimes it can be close to a 50/50 split.

Simple, right?

The Potential to Save Thousands

Yes, it’s a tax loophole. And, yes, admittedly, it may have been put in place to benefit corporate big wigs rather than small-time freelance finance. But if they’re taking advantage of it with their huge annual incomes, why shouldn’t you do so, too? As popular as this loophole is, there’s no official guideline on what the percentages should be for wages and dividends. Mainly, your wages have to look reasonable, and any good accountant will have your back and keep you honest. By taking control of your business and finances in this way, you’ll likely discover that there’s a lot more left in your bank account come quarterly tax season.

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