Self-Employment? I dread the paperwork …

On May 6, 2011, in Experiences, Good Advice, by Steffen Itterheim

One of the most commonly expressed dismissive statements regarding self-employment is all the paperwork that you’ll have to do.

Over the past ten years, whenever the discussion came to “How is it like to be self-employed?” or “Would you consider becoming self-employed?” the paperwork argument came up frequently and usually pretty quickly. I think that’s just an excuse, moreover I happen to know from experience that it’s just not nearly as bad as most people tend to think.

The amount of paperwork I do compared to when I was employed did barely increase, and most paperwork except tax reports were simply one-time events. Let’s have a look at what causes paperwork for self-employed and how to handle it.

Invoices & Accounting

As a self-employed, you’ll have to start writing your own invoices. And there are rules and regulations for a properly formed, legally acceptable invoice. But once you know these details, creating invoices is easy and much less daunting than you might think. It’ll become routine pretty quickly.

In fact, you don’t even have to know all the details. Not only are there various templates available for creating invoices with various Office programs, you also have the option to buy an Accountancy program. It’ll print your invoices and generally do so much more for less than $100.

Or you could simply use Paypal to write your invoices. The advantage in this case is that you can automatically get paid via Paypal by sending the invoice to someone else’s email address. I’m sure Google and other eCommerce providers have similar features.

As far as accounting is concerned, that’s a job done by my tax consultant.

Taxes

As an employee, the only thing I ever needed to do was a yearly income tax report. For years I haven’t done this myself. Instead I spent about an entire day collecting all invoices and receipts of the past year, put them in order and sent them off to my tax consultant. When I spoke to colleagues about this, some were almost shocked that I would be willing to spend €200 to €300 on a tax consultant when I could be doing the taxes myself.

However, for many years my tax return was 10 times or more than what I paid my tax consultant. And I also know from others that they utterly abhorred doing their taxes. They kept repeating for days or weeks that they’ve yet to do their taxes. Yet they refused to have them done by a professional. That’s simply self-damaging behavior. For avoiding the mental stress alone, plus the comfort of knowing that a professional will help me get even more money back from the state, hiring a tax consultant to do your taxes is the logical thing to do.

As a self-employed I now have to do additional monthly tax reports. But I’m spending less than 1 hour per month on collecting and printing my invoices and receipts and sending them off to my tax consultant.

In return I pay about €45 per month, or €540 total for the whole year. The good part is that these expenses are tax deductible in germany. In addition my paperwork is stored safely. In germany, you have to keep your entire financial records for at least ten years! That’s like keeping all issues of a 200 page monthly magazine for ten years! I don’t want to waste precious living or storage space on my paperwork.

For what it’s worth, and for the do-it-yourself types: the monthly tax reports are pretty simple. It obviously depends a lot on where you live and what type of legal entity you represent. But in the simplest case for a self-employed all that needs to be done is to calculate the sum of all invoices you issued or received, and the VAT paid. Then fill in the these sums in a few places on the tax form, and that’s it. In germany you can do all of that online with a program (Elster) that has helpful descriptions.

Company Registration

Depending on your country, there are various ways to register a company. Which one is right for you, and how much does it cost?

This is mostly a matter of informing yourself. There are authorities who will have the information ready for you, and who might even consult with you for free. In germany one would be the IHK. There are often a daunting number of options, but once you look a bit closer you’ll notice that 80% fall off the grid right away. And if in doubt, pick the company type that’s lower on the chart and cheaper to form – you can almost always upgrade later on with little hassle.

Once you know what kind of legal entity you want to create, the next steps are easy. In my case I spent less than 10 minutes filling out the paperwork at the town hall and have it signed and stamped. Done.

All other authorities were automatically informed and contacted me within a couple weeks with questionnaires about my work and expected revenue. Easy as long as you read them carefully. In some cases you want to opt out from membership and monthly payments explicitly.

Insurances

As a self-employed you are responsible for your health insurance, your pension funds, and other insurances that may or may not be necessary. Those not necessarily necessary include insurances for disability or legal costs, for example.

Personally what I did was to inform my existing health insurance about becoming self-employed and took their first offer after a quick price-check online. I could have saved a couple € per year by switching but the difference was marginal and didn’t seem worth the trouble.

As for state pension funds I decided to opt out and not pay over €1,000 per year. They can barely keep up with inflation whereas life insurance or investing in stock fonds (not the risky ones of course) offer a much better valuation over the years.

Should you get additional insurances when becoming self-employed?

Well, insurances are only really helpful when you do need them, and most of the time you don’t. Insurance companies play with our built-in feeling of wanting to feel safe. The “what if” scenario that we naturally worry about once we start to think about it. In some cases we’re paying a lot of money for something that we’ll possibly never take advantage of.

With all insurances you place a bet on statistics whether a particular event that an insurance covers will happen to you. In some cases, like health insurance or car insurance, you’re likely going to have to take advantage of that at some point in time. However, are you going to need the disability or legal insurance? Hard to tell but much less likely.

If in doubt, you don’t need additional insurances other than the ones you already have. If you think you do, my rule of thumb is to get insurance that will cover mostly the worst case scenario. In many cases you can choose how much you’re going to have to pay yourself in case of an event. If that’s an option I would pick the one that has me paying the most, in order to keep regular payments down to a minimum.

If the worst case scenario happens, the insurance should be able to cover everything that you can’t possibly and comfortably cover yourself, for example you might want to opt in on the offer that covers only costs above $2,000. By the time such an event actually happens, you would have likely spent close to $2,000 on the regular insurance payments if you picked an option that already covers all costs above $400, for example.

To repeat, the rule of thumb for insurances is that they should only cover expenses that could potentially ruin you. You should not pick what they want, which is the amount of money you’d feel comfortable spending in such an event.

Paperwork.exe caused an Exception

Among the biggest worries that I’ve had, and others I know have expressed, is the fear of doing something wrong with your paperwork. Mistakes can be costly, they can lead to prosecution, fines and even imprisonment. So you’d better not want to make a mistake.

However, the truth is that those are worst case scenarios. I’ve made some mistakes in my paperwork or forgot to send them in timely. What really happened?

In one case I got a note from my tax consultant to make sure not to make the mistake again, in the other case I got a phone call from my tax agent informing me about the situation. They had already sent me two warning letters that I’ve never received. We discussed the issue, I fixed it, no further problems and no fine.

The thing is: if you’re small peanuts for the tax authorities, most of your mistakes will be forgiven, overlooked, ignored or not even noticed. Especially first-time offenses and those that don’t carry any signs of fraud or criminal intent.

For most newly self-employed this is a learning process and the tax authorities are aware of that. My personal experience with them has been that they’re just humans. If you don’t treat them like your enemy they will be your friends. After all, they don’t make the laws.

There’s Always Help

If you do run into a problem or have a question but don’t want to pay a tax consultant I’ve made the experience that you can simply call up the responsible tax agent and ask the question or discuss the issue. There are also courses and hotlines that you can take advantage of, most of them are free or charge only a nominal fee. Taxes & Co. are really nothing to be worried about if you’re just starting out.

The only thing that you should not do is neglect your responsibilities. Mainly to inform yourself, to do your taxes and just do the necessary paperwork with a positive attitude. And I believe that’s where most people are quite easily put off. You’d also be surprised how much valuable information is available on Wikipedia. It has been a great help and frequenlty provided better, more accurate and easily understandable facts than most Internet websites dedicated to the topic.

The additional paperwork for self-employed is a responsibility – but that responsibility is almost negligible once you learned what is actually required from you and that mistakes most likely don’t carry the severe penalties that you might worry about.