Being self-employed allows you the opportunity to work on your own terms. This freedom and control is enticing for many individuals, though one potential drawback is the need to manage your own taxes. Do you just wait until tax day and the unpleasant surprise of how much you owe? Do you rely on accounting professionals to assist you? How much should you set aside and when should you pay?
Today we’re helping self-employed individuals understand their tax obligations and exactly how to pay them so that you can focus on what matters—growing your business.
What taxes do I pay when self-employed?
When you are self-employed, you are responsible for both the employer and employee side of taxes. In a traditional business, there is a set of taxes withheld from employee paychecks and paid by their employers. Since self-employed individuals are essentially operating as their own employer, they are responsible for this set of taxes.
In other words, self-employed individuals are responsible for the same taxes as other working individuals, as well as the taxes paid by employers. These obligations include:
- Income tax: Required of all Americans and businesses, paid as-you-go
- Self-employment tax: Social Security and Medicare requires 15.3% of your income
- Sales tax: Almost all states require a tax on sales, and you may also be subject to city and county taxes. Sellers collect sales tax and pay the requiring states, cities, or counties regularly.
*Note: Small businesses, freelancers, sole proprietors, and anyone expecting to owe more than $1,000 in federal taxes in the current year should calculate and pay estimated quarterly taxes.
Self-employed individuals pay a 15.3% self-employment tax on top of their income tax.
The most complicated feature of taxes for freelancers and self-employed individuals is the aptly named Self-employment (or SE) tax. Medicare and Social Security taxes are required of all Americans. Employers usually withhold 7.65% from each paycheck, and then match that to pay the required 15.3% FICA tax. Self-employed individuals pay the entire 15.3% by themselves, and are then able to deduct 7.65% that would have been paid by a traditional employer on their behalf.
How to calculate self-employment taxes
Use the IRS Form 1040-ES for the most current guidelines, rules, and methods for calculating quarterly taxes as a self-employed individual.
1. Determine tax bracket
The 2020 Tax Rate Schedule is first determined by your filing status (Single, Married filing jointly, Married filing separately, and Head of Household) and your income. Your federal income tax bracket will determine how much you should be paying as a general foundation.
For example, someone making $95,000 annually and filing jointly as a married couple has a 22% tax rate. They’ll owe $9,235 plus 12% of the amount over $80,250 (which comes out to 1,770), totaling $12,775 in taxes for 2020. But that’s without any deductions or credits, so you can reduce your taxable income.
2. Determine deductions & credits
For the year 2020 the standardized deductions are:
- $24,800 for married filing jointly
- $18,650 for head of household
- $12,400 for single or married filing separately
Standardized deductions are automatic, much faster, and easier. However, if you think that your itemized deductions will total more than the standardized deduction for which you qualify, it may be worth the extra time and forms to file itemized deductions.
Some business expenses can still be deducted via Schedule C in addition to a standard deduction, so you’ll want to ask your tax preparer to clarify what you are eligible to deduct.
What can you deduct?
- Home office
- Internet & phone bills
- Health insurance premium
- Meals related to business
- Travel related to business
- Vehicle use related to business
- Interest on business loans
- Education, publications, subscriptions
- Business insurance
- Retirement plan contributions
Once you decide on your deduction strategy, you can total and subtract that amount from your taxable income. Using our prior example, if the individual making $95,000 and filing jointly with their spouse decided to take the standard deduction of $24,800 then their taxable income would decrease to $70,200. This would drop them to a 12% tax bracket. They would owe $1,975 plus 12% of the amount over $19,750 (which comes out to $6,054), totaling $8,029 in taxes for 2020.
3. Add self-employment taxes
For the year 2020 self-employment tax is 15.3% up to $137,700 and 2.9% on any net income above that threshold. You can claim half of that on your deductions, since usually the employers pay half of Social Security and Medicare taxes for regular employees. As a general rule 92.35% of your net income is taxable for self-employment.
So our married couple making $95,000 would multiply that income by 92.35% to determine their taxable net earnings for self-employment (which comes out to $87,732.50). That amount is subject to the 15.3% tax rate, totalling about $13,424 in self-employment taxes owed. They will need to add that to their taxes paid throughout the year, but then they can deduct 50% ($6,712) when they file at tax time, dropping their taxable income from $70,200 to $63,488.
4. Calculate final taxable income, tax liability, and estimated quarterly tax payment
After jumping through these many hoops we can land on the final taxable income, deductions, and taxes due. Using our example couple, the $95,000 income minus standard deductions and self-employment deduction leaves them with $63,488 taxable income which assigns them a 12% tax rate. They’ll owe $1,975 plus 12% of the amount over $19,750 (which comes out to 5,248.56).
- $1,975 + $5,248.56 = $7,223.56 income tax
- $13,424 in self-employment taxes
- Total $20,647.56 owed in taxes annually
- Quarterly payments of $5,161.89
Planning for self-employment taxes
Once you have a total for your estimated taxes, you need a strategy for setting the money aside so you’re not surprised each quarter, or worse—at tax time. Here are two tried-and-true strategies for managing your quarterly estimated tax payments.
Monthly: Divide your annual estimate by 12 and transfer that amount into a separate tax or savings account each month.
Percentage: Figure out the percentage of your income that will be required, then transfer that percentage of each payment to your tax or savings account. For example, if you will be paying 20% of your income in taxes, you’ll take 20% of each paycheck and transfer it directly to your tax or savings account.
The strategy that works best for you will depend on the stability of your freelance income and any expenses that offset that income. Play around with the numbers to determine which makes more sense for your situation.
How to file taxes
Quarterly estimated tax payments can be mailed using the printable vouchers in Form 1040-ES or use IRS Direct Pay to pay online. State and local taxes may not require quarterly filing, and may have their own procedures for payments, so work with a tax professional to be sure you’re paying taxes correctly.
Tax deductions and credits for self-employed individuals
Deductible expenses are defined by the IRS as expenses that are ordinary and necessary.
- Ordinary expense: Common and accepted in your trade or business
- Necessary expense: Helpful or appropriate for your trade or business
Frequently asked questions
When do I pay taxes?
The IRS updated the 2021 tax filing deadline from April 15 to May 17 for individual filings (which includes self-employed individuals). Quarterly taxes for businesses are due April 15th, June 15th, September 15th, and January 15th. Annual tax filings are due April 15th. Use our handy small business tax filing deadline calendar to stay on top of your tax obligations.
How do you show proof of income if you are self-employed?
You can show proof of income as a self-employed individual by showing annual tax returns, bank statements, or profit-and-loss statements.
How much money should a self-employed person put back for taxes?
The amount you should set aside for taxes as a self-employed individual will be 15.3% plus the amount designated by your tax bracket.
What is the self-employment tax rate for 2020?
The self-employment tax rate for 2020 is 15.3%.
Do self-employed individuals pay more in taxes?
The short answer is yes, self-employed individuals usually pay more in taxes. However, they are also able to deduct half of the self-employment tax, as well as business deductions like home office and operations expenses.
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