Bookkeeping and Tax Requirement for

Freelancer/Self-Employed/Home-based Businesses
Written by: Maria Lourdes M. Yanuaria, CPA

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In the past years, there has been an increased in individuals who do

freelancing, as a means to generate income rather than being
employed. These are individuals who prefer to be either a self-
employed (offering their knowledge, talents or skills) or sole-proprietor
of a business (selling goods or services). Although many succeed as
freelancer, they oftentimes end up losing their earnings because of
their inability to account and manage their finances. Additionally, they
end up paying large amount of tax and penalties because they fail to
comply with tax and other government requirements, after they
register as self-employed or sole-proprietor.

This article will guide you on the basic bookkeeping and tax
requirements that freelancer, self-employed, or sole-proprietor must
monitor and comply with to avoid future problems. Though the title
implied that this is for freelancers, it is also applicable for small
business owners, home-based businesses and all businesses
registered as sole proprietor.

Register your home-based or freelance business

If you want to be taken seriously as freelancer, the first thing you need
to do is to get registered basically to the following government
agencies:

Department of Trade Industry (DTI). To secure a trade name or

business name.
 Local Government Units (LGUs), such as Barangay and Mayors
Office. If you are a Professional registered in Philippine
Regulatory Commission (PRC), you may skip this.
Bureau of Internal Revenue (BIR). To secure a new Tax
Identification Number (TIN) or update your registration.
For more details on registration, please see our article How to
Register a Sole Proprietor Business in the Philippines?

Maintain accounting books

After you register, the next step is to keep an accounting record.
These are the following accounting books applicable to freelancers:

General Journal
General Ledger
Cash Receipt Journal
Cash Disbursement Journal
Important Note: Make sure that your accounting books are registered
with the BIR.

For more details on accounting books please read our article What are
the Books of Account?

Issue BIR Registered Invoices and/or Receipts

After registering, and before you start operating or offering your
services, register your invoices and receipts with the BIR.

For manual invoices and/or receipts

Look for an accredited printer who will do the printing of
your invoices and/or receipts.
For computerized invoices and/or receipts, Point-of-Sale(POS),
Cash Register Machine (CRM), etc
Register your computerized system with the BIR.
For more details on invoices and/or receipts, please read our
article Difference Between Sales Invoice and Official Receipt

Keep the receipts of your expenses

Its typical for business, even freelancers, to incur expenses in order to
operate. Expense is deducted from gross sales in order to come up
with the net income. As such, ensure that you keep your expense
receipts so you can determine the true financial performance (or
profit).

File and/or pay the tax returns on time

Once youre registered with the BIR, keep in mind that you are
required to pay or file monthly and quarterly tax returns, as follow:

Monthly

BIR Form 1601E if you are renting, paying professionals or

commissions. This is due for payment or filing on or before 10th of
the preceding month.
BIR Form 2551M For Non-VAT individual. It is the computed
sales tax equivalent to 3% of monthly gross sales. This is due for
payment or filing on or before 20th of the preceding month.
BIR Form 2550M For VAT individual. It is computed sales tax
equivalent to 12% of monthly vatable sales less 12% of vatable
purchases/expenses. This is due for payment or filing on or before
20th of the preceding month.
Quarterly

BIR Form 2550Q For VAT individual. It is similar to BIR Form

2550M, but instead of one month, it reports the three months in a
particular quarter. Its due for payment or filing on or before 25th of
the preceding month after the close of the quarter.
 BIR Form 1701Q This is the income tax for the quarter. Its due
for payment or filing on or before the 60th day after the close of
the quarter.
Renew your licenses annually
Once registered, you need to renew your licenses and permits to
LGUs on or before January 20th of each year.

File and/or pay annual reports

Last but not the least, on or before April 15th of each year, you need to
file or pay BIR Form 1701 Annual Income tax return based on your
net income for the preceding year.

It is said that prevention is better than cure. To avoid future headaches

and problems, its best if you monitor compliance to these
bookkeeping and tax requirements. One good reason for keeping a
good accounting record is that, your future investors for your
expansion might require it someday. You will never know that your
small/freelance/home-based business is the real next big thing.

A sole proprietorship is a business owned by one person. Sole proprietorships are more
numerous than any other form of business structure in the United States but typically they are
smallest in size. Accounting for sole proprietorships is very similar to corporate accounting; the
differences being in the equity account area.

There are two equity accounts for a sole proprietorship, a capital account and a withdrawal
account. Since a proprietorship is not a corporation there are no capital stock, retained earnings,
or dividend accounts. Owner's investment is credited to a capital account. Similar to
corporations, revenue and expense are closed out to an income summary account. Income
summary, however, is closed out to capital. The withdrawal account is also closed out to
capital. Note that owner investment and the effects of net income and withdrawals are all
contained in the capital account.

For example, if Jane Smith invests $100,000 in a sole proprietorship, the entry to record the
investment would be:
 Cash 100,000
Jane Smith, Capital 100,000

After revenue and expense accounts are closed to income summary, final closing entries
assuming net income of $20,000 and withdrawals of $12,000 would appear as follows:
Income Summary 20,000
Jane Smith Capital 20,000
Jane Smith, Capital 12,000
Jane Smith, Withdrawals 12,000

A partnership is an association of two or more persons who co-own a business. Accounting for
partnerships is similar to accounting for a sole proprietorship except that each partner has a
capital and a withdrawal account.

Accounting for initial investment of partners is similar to that for sole proprietorships. Any non-
cash assets contributed by partners are recorded in the partnership records at fair market value
not historical cost.

Distribution of partnership profits and losses can be accomplished a number of ways and the
distribution is invariably spelled out in a partnership agreement. Some common methods include
distribution based on stated ratios; based on capital balance ratios; based on "salary", interest,
and stated ratios; etc. Partnership drawings are recorded similar to those of a sole proprietorship.

There are two ways in which a new partner can be admitted to a partnership:
1. Purchase original partner's interest
2. Invest assets into the partnership

Regardless of the amount paid an original partner, the entry to record admission to the
partnership by purchasing an original partner's interest would be:
Original Partner's Capital
New Partner's Capital
The amount debited and credited would be the original partner's capital balance.

To record admission when the new partner invests assets in a partnership, both the assets of the
partnership and partners' capital accounts increase. Depending on the amount invested by the
new partner, there may be a bonus to the old partners or to the new partner. I find it helpful in
analyzing admissions to a partnership to use the accounting equation before and after
admission. Especially when there is a bonus involved, the accounting equation can be helpful to
determining the impact on respective partners' capital accounts.

There are several ways in which a partner may withdraw from a partnership. At withdrawal, an
appraisal should be made of the assets to restate them at market value and adjust the capital
accounts accordingly.
If the withdrawing partner simply sells his/her interest to one of the remaining partners the entry
is as follows:
Withdrawing Partner, Capital
Purchasing Partner, Capital
Similar to an admission, the amount debited and credited is the balance in the withdrawing
partner's capital account regardless of how much was paid by the purchaser.

In the event the withdrawing partner withdraws assets from the partnership itself a bonus either
to the remaining partners or to the withdrawing partner may be involved.

Liquidation of a partnership is the act of going out of business and consists of the following
steps:
1. Sell all assets. Allocate gain or loss to partners based on their profit/loss ratio.
2. Pay off all liabilities.
3. Disburse remaining cash, if any to partners based on their capital balances.

Accounting for a sole proprietorship

The accounting for a sole proprietorship does not require a separate set of accounting records, since
the owner is considered to be inseparable from the business. Nonetheless, one should maintain
records for business activities, in order to judge whether these operations are generating a profit.

A sole proprietorship tends to generate smaller amounts of revenue and incur lower levels of expenses
than more complex types of organizations. Consequently, it can make sense to start off with the most
minimal accounting record keeping that is based on the cash flows into and out of a bank account.
This means maintaining separate cash receipts and cash disbursements journals, and little else. This is
considered a single entry accounting system, since it cannot be used to produce a balance sheet, only
an income statement.

A single entry system is most suited to a cash basis accounting system, where revenues are recorded
as cash is received, and expenses are recorded as payments are made. There is no attempt to track
assets or liabilities, so there is no formal tracking of fixed assets, inventory, and so forth in separate
journals.

The tax reporting for a sole proprietorship flows through the owner's personal tax return, with a
separate form used to itemize the major classes of revenues and expenses incurred by the business.
There is no separate tax return for the business, since there is no separate business entity.

The main limitation of this accounting system is that there are insufficient accounting records to be
translated into an auditable set of financial statements. If the owner of a sole proprietorship wants to
obtain funding for his or her business, the lender will likely require audited financial statements, which
will require the following sequence of actions to upgrade the accounting records:

1. Form a business entity

2. Switch to the accrual basis of accounting, using a double entry bookkeeping system
 3. Have the resulting financial statements audited by a CPA

This represents quite an upgrade in complexity from the basic accounting system outlined earlier for a
sole proprietorship.

Steven Bragg | in Bookkeeping Share Article Posted on Wednesday, May 20, 2015 at 5:05PM

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What Are the Accounting Principles for a Sole

Proprietor?
by Devra Gartenstein

RELATED ARTICLES

Profit Retention in a Sole Proprietorship

Sources of Investment in a Sole Proprietorship

Attracting Capital in a Sole Proprietorship

Relationship Between Sole Proprietorship & Entrepreneurship

The Three Types of Business Entities in Accounting

Sole Proprietorship Accrual Vs. Cash

Sole proprietorships are businesses that are intimately linked legally and
financially with their owner operators. When a sole proprietorship loses money,
its owner takes a personal loss and when it earns money he is taxed on it as
personal income. Accounting principles for a sole proprietorship should create
enough of a division between a business owner's personal and business
finances to determine which expenditures are legitimately tax deductible. At the
same time, a sole proprietor's accounting system should integrate the connection
between business and personal finances by tracking the flow of funds between
different accounts.

Banking

Sole proprietors are not required to have separate bank accounts for their
businesses. However, they are required to keep track of which transactions are
personal expenses and which accrue to their businesses. Keeping a separate
business account makes it simpler for a sole proprietor to separate business and
personal purchases. A sole proprietor who does not have a separate business
account can track purchases and business revenue by keeping sales and
purchase ledgers, and entering relevant information using purchase receipts and
billing invoices.

Profit

For a sole proprietorship, taxable profit is the amount left over after subtracting
operating expenses from gross revenue. Sole proprietors are liable for income
taxes on this net amount regardless of whether or not the owners withdrew
money for personal use. Sole proprietorship accounting for tax purposes should
track profit by tallying income and expenses. However, sole proprietorship
accounting for cash flow and business management purposes should also focus
on how much money the owner withdraws or adds to business operating funds.

Financing

A sole proprietor's personal credit is the basis for his business financing
prospects. A sole proprietor's strategy for funding cash flow shortfalls depends on
the owner's personal resources and ability to provide operating capital out of
personal accounts and also on his tolerance for risk and willingness to incur
personal debt. Sole proprietorship accounting should be as objective as possible
when evaluating these options, making careful projections and considering
multiple scenarios.
 Purchasing

A sole proprietor has the final decision-making power when making business
purchases, but she won't be able to buy anything if she doesn't have the money.
Sole proprietorship accounting can facilitate purchasing processes by providing
information about cash flow and profit. These numbers should offer insights as to
whether the purchase has the potential to improve the company's bottom line by
introducing efficiencies or lowering costs and whether the business has the
resources to afford the expenditure.

References

Entrepreneur: The Basics of Sole Proprietorships

IRS: Sole Proprietorships

Nolo: Sole Proprietorship Basics