Self-Employment: 5 Essential Information to Keep in Mind

When you finish reading this article, you will know how to prove your money, be trusted, and be clear about your money matters.

1. Demostrating Income for Freelancers

Self-employment brings joy and a sense of work gratification, but it can be tedious to prove your income as a freelancer since it varies occasionally. This means that you need to get more involved in the billing and documentation process of every aspect of your business.

1.1. What is Self Employment

Working for yourself is like being the boss of your own business, where you get to make all the decisions and get all the money you earn. It’s like running your show. This can be exciting because you are in control, but it also means you must take care of your finances independently.

1.2. Why It is Important to Prove Your Money

Proving your money is like showing a report card about your finances. It is a way to demonstrate that self-employed individuals are good at handling your money and can be trusted.

This is very important when you want to borrow money to grow your business, apply for health insurance, buy a car, or look for a place to live. Sometimes, tax agencies, investors, and banks need to see papers that show how much you make. They need assurance that you can make regular payments.

Also, it helps you keep track of your own money. It is like having a strong foundation for managing your finances, and it builds trust in your professional activities.

Documenting Self-Employed Income

From my extensive financial planning and advisory experiences at BlueSky Wealth Advisors, I’ve observed critical differences in financial management tactics between those traditionally employed and self-employed individuals.

A prime example is the approach to documenting and proving income. While traditional employment typically offers clear, regular proof of income through W-2 forms, self-employment requires a more nuanced and comprehensive approach.

This often includes providing detailed profit and loss statements, tax returns, and sometimes bank statements to establish a history of income.

One particularly illustrative case involved a self-employed consultant who, despite generating significant income, faced hurdles in securing a mortgage because of the irregular nature of her earnings.

By meticulously organizing her financial records and utilizing sophisticated tax strategies we devised, she could not only prove a consistent income to lenders but also maximize her tax efficiency.

This approach underscores the importance of advanced financial planning and the utilization of specialized knowledge in tax strategies for those who are self-employed.

Moreover, the need for a documented financial strategy became even more evident during the COVID-19 pandemic. For our self-employed clients, navigating through the various stimulus programs required an intimate understanding of their financial operations.

When assisting them with applications for the Paycheck Protection Program (PPP), implications from tax deductions, and choosing the right method to calculate payroll costs, highlighted how a detailed financial strategy could significantly impact eligibility and potential loan forgiveness.

These examples from my practice emphasize the necessity for self-employed individuals to engage in meticulous financial planning and sophisticated tax strategies to not just prove their income but to ensure their financial stability and success.

David Blain, CFA, Chief Executive Officer, BlueSky Wealth Advisors

2. Self Employment Income

When you are your own boss, your money is called self-employment money. It is very important to understand where this money comes from and how it is not the same as the salaries people get from regular jobs.

2.1. Sources of Self-Employment Income

When you embark on the journey of freelancing, then you will need money for marketing and running the business. You can get finance from various sources like crowdfunding, investors, and bank loans. However, you are still the sole proprietor. Sources of self-employment income can be from freelancing gigs and running a business.

2.2. Comparison With Traditional Employment

Let’s see how getting money when you are your boss differs from having a normal job. In a traditional job, a company or someone else pays you every few weeks and deducts payroll taxes.

However, self-employed people have to track how much money they make. It gives you more freedom and sometimes more money. But you would not automatically get things like Health insurance or retirement plans. You have to plan for those yourself. Knowing where your self-employment money comes from and how it differs from traditional job money helps you handle it well.

This will be important when we talk about how to prove your income when self-employed in the next parts.

3. Methods for Providing Income Proof

There are many different ways to prove how much money you earn. These are bank and financial statements showing what you do with your money. Also, they help you to prove how much money you make.

So now we are going to talk about incredible methods to prove your income when you are self-employed.

3.1. Bank Statements

Bank statements are like detailed reports from your bank that provide a comprehensive look into all the transactions of an individual or business over a certain period. It clearly shows how much money has come or is being withdrawn from your account. Therefore, you need an exclusive bank account for your self-employment income.

3.1.1. Why Bank Statements are Important

These statements are critical when showing how much money you make. They show the place where your cash comes from and where you spend your income. Also, it is known as your profit and loss statements. Simply put, bank statements are like a mirror that reflects how money comes and goes from you.

Every bank statement showcases various elements such as account information, withdrawals, deposits, fees, and balances. They are crucial for you when you need to show your net income to others or when you want to apply for a loan and track your income activity.

3.1.2. How to Keep Bank Statements Well

To use bank statements effectively, it is very important to keep them in order. This means stashing them in a spot that’s safe and easy to grab when needed.

Keeping them safe also protects them from getting lost or damaged. Hard copies of your statements should be kept in a fireproof safe, while electronic copies should be safeguarded in a file with a password.

3.2. Tax Returns and Documentation

Every year, you fill out special papers called tax returns. These papers tell the government how much money you make. The World Bank recommends each country collect at least 15% of its GDP to meet its basic needs. They are very important to prove your income.

3.2.1. Primary Proof of Income

Income tax returns are trusted because they go to the government. They clearly say exactly how much money you get in a year. When you do your tax return, you share details about how much you earned and anything you can deduct. One of these is money spent on your business, which can reduce the amount of money you must pay taxes on.

3.2.2. Making Sure Everything is Right

Getting things right is very important when you are doing taxes. This means making sure all the information you give is correct. Also, you need to list all the avenues where you get money. This ensures your tax return says the right amount of income.

3.2.3. Legal Requirement by Law

Most countries have laws requiring every individual with taxable income to file tax returns over a certain period. Filing late or failing to file tax returns can have dire consequences, such as facing penalties.

You should put in all the papers and information that you are supposed to. This might mean you have to keep good records all year. So you don’t forget anything when it’s time to do your taxes.

3.3. Profit and Loss Statements

A profit and loss statement is like a report card for your business. It shows how much money your business made and spent during a certain time, like a month, three months, or the whole year. It is like taking a quick picture of your money situation. Self-employed individuals are not necessarily required to provide P/L statements, but they are essential to track finances.

3.3.1. Showing Your Business’s Health

Think of it like a game score. The money you make and spend is like your points. It is a trusted paper that clearly says how much money your business has. Also, it tells the truth about how well your business is doing with money.

When you make this statement, you write down how your business gets money, like selling things or doing services. Also, you write down all the things your business spends money on, like rent, electricity bills, vehicles, and any other financial obligations. This is important when you are filing tax returns.

3.3.2. Making Informed Decisions

You have to write down every way your business makes money and every way it spends money. To make a good profit and loss paper, you need to be very careful with the numbers. This way, the paper will show exactly how your business is doing with money. For instance, you can calculate the revenue that the company is making.

Being complete is just as important. Also, you must put in all the papers and information you are supposed to. This might mean keeping good records all year so you don’t forget anything when it’s time to make your statement.

Remember that this profit and loss statement is a tool to showcase the business’s performance and help make future financial decisions. So it is very important to do it right and ensure you include everything, just like with those special papers for the government.

3.4. Financial Statements

Financial statements refer to written data that is used to assess the performance of the business. Every self-employed individual is required to know the basics of accounting for any gig to run smoothly. They can be in the form of balance sheets or income statements. They show how much money your business has and where it comes from. Some of the benefits of financial statements include

3.4.1. Financial Awareness and Visibility

Just like when you look at the money you get from your allowance or birthday, financial statements are prepared by organizations to showcase the overall performance and activity. They show key financial information such as the balance sheet, cash flow, and income statement.

When you make a financial statement, you write down all the places where your business gets money, including selling things, doing services, or other ways your company makes money. You also write down all the things your business spends money on, like house rent, electricity bills, mobile recharges, water bills, and other expenses.

Proactive Financial Management for Self-Employment

In transitioning from military law and corporate real estate background to running my own short-term rental management company and law firm for real estate investors, I’ve navigated the financial management challenges between traditional employment and self-employment firsthand.

Traditional employment often provides a predictable income, making it straightforward to prove income through pay stubs or a W-2 form.

However, self-employment demands a more proactive and detailed approach to financial documentation because of its inherently variable income.

One strategy I’ve found particularly effective in managing and proving income as a self-employed individual is the meticulous use of financial management software tailored to real estate investments and short-term rental operations.

For instance, tools like QuickBooks or Xero allow for the organization of both expenses and income streams in detail. They enable me to generate financial reports that thoroughly document income over time, which is essential for tasks like securing loans or making investment decisions.

Moreover, diversifying income sources has not only provided financial stability but also facilitated easier income verification from multiple streams.

Through managing rental properties, legal consulting, and educational roles, I’ve been able to present a holistic view of my financial health that goes beyond simple income statements.

For example, demonstrating consistent rental income alongside legal consulting fees has supported loan applications and investment opportunities. 

This approach highlights the importance of a diverse portfolio and robust documentation in proving income for self-employed individuals, offering a template that can adapt to the unpredictable nature of self-employment income.

Garrett Ham, CEO, Weekender Management

3.4.2. Saving Your Money

Just like when you put your money in a piggy bank to keep it safe, you must keep good business records. This means writing down every way your business gets money and every way it spends money. Tracking your finances will keep you at bay for how the company is performing.

Financial statements are a requirement by law for self-employment ventures in most countries. Also, they provide insight to stakeholders, creditors, and investors to help them make informed decisions.

Address Income Variability with Records

In my extensive experience as a CPA and family office executive, one of the most prominent challenges freelancers face is the variability of their income, making it difficult to prove steady earnings.

This variability often leads to hurdles when attempting to access financial services or opportunities, such as loans or lines of credit. Frequent changes in income can be particularly problematic when financial institutions seek evidence of consistent earnings over time.

To mitigate these challenges, I’ve discovered that one effective strategy for freelancers is to maintain immaculate financial records. Utilizing robust accounting software like QuickBooks, Xero, or FreshBooks can be a game-changer.

These platforms enable freelancers to document their income and expenses accurately, providing a solid foundation for financial reporting.

Moreover, generating a profit-and-loss statement periodically can offer a snapshot of their financial health, serving as concrete evidence of their earning capabilities over time.

Additionally, during my time managing tax planning and oversight for a Forbes 400 family, I recognized the importance of forward-thinking financial strategies, including tax planning and retirement contributions.

For freelancers, establishing a self-employed pension (SEP) or a similar retirement account not only aids in long-term financial security but can also serve as evidence of an organized and financially prudent individual.

Pairing disciplined record-keeping with strategic financial planning presents a comprehensive approach to overcoming the common challenges freelancers face in proving their income and enhancing their ability to access vital financial services and opportunities.

John F. Pace, CPA, Tax Partner, Pace CPA

3.5. Pay Stubs and Business Expenses

A pay stub is a record of all the important information of your business. It includes net income, deductions, and all other contributions. They are like a detailed map showing all the details about your financial situation. Paystubs are very beneficial for self-employed individuals.

3.5.1. Evidence of payments

Pay stubs are your proof of income, just like when you receive money for helping out or doing chores. For instance, a pay stub will come in handy when you are looking for a loan. Also, they show where your business uses its money.

3.5.2. Keeping a Record

Just like how you keep track of your toys or games, you also need to record all your pay stubs and business expenses. You should include all your pay stubs and information about business expenses. In this way, your record shows the right financial information.

Average Monthly Income for Clarity

Freelancers often ride a financial roller-coaster, making it tricky to prove steady income for loans or mortgages. This feast-or-famine cycle leads to volatile earnings, posing a challenge when accessing financial services.

However, by tracking and averaging monthly income, freelancers can paint a clearer picture of their annual earnings.

This method, along with proper documentation, helps in effectively communicating with lenders, easing the path to qualifying for financial opportunities despite the irregular income pattern.

Marco Genaro Palma, Freelance CMO and SEO Consultant, GenaroPalma.com

4. Special Considerations for Independent Workers

When you are self-employed, handling your money becomes very different for you. It is not just about doing your job but also understanding how to get a home loan and dealing with taxes.

So, in this part, we are going to talk about important things for people who work for themselves to get a home loan and speak to the Canada Revenue Agency.

4.1. Mortgages for Entrepreneurs

Getting a home loan when you are self-employed can be very tricky for you. Lenders require all the financial documents to make sure that you have a steady income. They could be things like tax forms, revenue forms, and bank statements. Having these papers available can make a big difference when you ask for a loan.

Also, it is necessary to find a bank that understands self-employed people. They can give you some good advice that helps you through the process of taking out a loan. Also, you can seek experts who can give you good advice that fits your special situation so you can make the best decisions for your business venture.

4.2. Interactions With Canada Revenue Agency

The Canada Revenue Agency is a department that collects taxes on behalf of the Canadian government. It applies different taxing methods for self-employed individuals, which are different from those for people who have regular jobs.

One thing to know is the difference between the money you make from your business and personal income. Keeping track of these two kinds of finances is very important for telling the CRA about your income. It is also very important for you to keep an eye on any new rules or changes the CRA makes.

This is one of the accurate tricks for you to always do your taxes right. If you are unsure and confused, then it is a good idea to ask someone who knows about taxes for self-employed people. They can give you the right advice and help you with the special rules of the Canadian Revenue Agency.

5. Being Clear and Honest

People need to trust your business. Proper documentation will earn your customers’ loyalty and make them more comfortable.

5.1. Keeping Money Records

Keeping good and organized records of all your money stuff is very important. This helps you a lot in understanding how and where you earn money and then where you spend it. Also, it makes people feel good about doing business with you.

Organizing record-keeping is like having a map that shows you all the important places where your money has been. It is helpful for you and anyone who wants to see how well your business is doing.

5.2. Working With Your Bank

Having a strong and reliable relationship with your bank is a big deal. It means you can trust them with your money and they can help you to show how much you earn. This is very helpful for you, especially if you are self-employed.

Your bank can be a strong helper in showing proof of self-employment income. They can give you financial statements and advice that make proving income easier. This way, people have even more confidence in your business.

Final Thoughts

Now that you understand self-employment, you know it has become a lifestyle. It allows you to make your own money on your own terms. However, the downside is that you are required to prove your income. There are different ways to prove it, like using bank statements and tax returns.

This is like a report card for your money; it helps people trust you and know you are good with your money. However, it is crucial that you go through the financial documents before submitting them to anyone.

If you want to enjoy all the perks of self-employment, you must keep an up-to-date record of all your finances. Health insurance for you and your family or your retirement plans, you must plan for yourself. The road to self-employment might not all be bed roses, but once you understand the minimal requirements of proving your income, you are on the right track.

FAQs

Q1. Why is It Important to Show How Much Money I Make When Working for Myself?

It is very important because it helps with things like getting loans from a bank or finding a lease apartment. Also, it makes people trust you with your money.

Q2. Why are Tax Forms Important for People Who Work for Themselves?

We all know that tax forms are official papers that show how much money you earn and what you can subtract. They are trusted to show your income, especially if you are self-employed.

Q3. How can I Make Sure My Money Records are Clear and Honest for My Business?

Keep good and organized records of your money. Also, maintain a positive connection with your bank. This thing shows how much cash you’re pullin’ in and makes folks have faith in your hustle.

Guest Author: Saket Kumar

Last Updated on April 11, 2024 by Saket Kumar