The prospect of making money on your own terms can be exciting, but many self-employed people underestimate them tax obligations.
“I knew taxes were going to be exorbitant when I first started freelancing, but I was shocked when it came time to pay them,” says Loris Wardini, a freelance writer and co-founder of ClothedUp. “I didn’t prepare properly and stood with a huge bill at the end of the year,” she adds.
To prevent unwanted surprises, freelancers need to monitor their tax obligations throughout the year. If you’re not sure where to start, here’s a look at how taxes work for freelancers and how much you need to put aside.
How taxes work for the self-employed
Once you become a self-employed business owner, the first thing you need to know is that your taxes are twofold. You will likely have to pay an amount self-employment tax with income taxes.
If you make a net profit of at least $400 as a self-employed individual, the Internal Revenue Service requires you to a file Schedule SE and pay 15.3% self-employment tax. Of the 15.3% tax rate, 12.4% goes to Social Security and 2.9% goes to Medicare. However, you will not have to pay the Social Security portion of the tax on earnings that exceed the program’s annual income limit ($147,000 for 2022).
Individuals can deduct half of their employer’s self-employment tax when calculating adjusted gross income. Doing so will help reduce the amount of income tax due. However, it will not reduce net self-employment earnings or self-employment tax.
Next, income taxes are levied on the adjusted gross net income of both businesses and individuals. As a freelancer, you may be responsible for taxes at the federal, state, and regional levels. Here’s a little about each:
- Federal income tax The rates are progressive and currently range from 10% to 37% for 2022. You are likely to pay multiple rates that increase as your income increases.
- Forty-one states tax income in varying proportions. The nine that are not are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
- provincial income taxes Less common but found in a few countries. It is most often collected by cities, but may also be collected by counties, school districts, or special districts.
Your income tax liability will depend on where you live, your tax filing status, and how much money you earn. For this reason, you will need to do some research to find out what you have to do. Usually, you can find income tax laws and rates posted on state and territory government websites.
When do freelancers pay taxes?
The next question is, when are taxes due for the self-employed? If you expect to owe at least $1,000 when you file your return at the end of the year, the IRS requires you to make estimated quarterly payments. For tax year 2022, the payment due dates are as follows:
- one quarterDelivery date: April 18, 2022.
- Second QuarterDelivery date: June 15, 2022.
- Third quarterDelivery date: September 15, 2022.
- The fourth quarterDelivery date: January 17, 2023.
To avoid tax penalties, it is important to make your estimated payments on time and at the best estimate of the amounts owed.
How much do freelancers need to allocate taxes?
If you work as a freelancer and generate at least $400 in net income, you will need to set aside 15.3% of your net earnings for self-employment tax and enough to cover your income taxes.
To find out how much to set aside for income taxes, check the income tax rates that apply to you at the federal, state, and territorial levels. Associate them with the self-employment tax to get the total percentage you will allocate.
For example, Andrew Marshall, a certified self-employed financial planner, says, “I put in 30% because I live in California and my self-employment tax, plus state and federal income taxes, is just under a third of the income.”
Tax planning tips for the self-employed
Once you know how much to put aside, how are you going to proceed to save it? Marshall advises, “Every time a client pays me, I transfer 30% of their payments to my tax savings account. Then, I pay estimated taxes quarterly using that money.”
While you can also allocate your estimated taxes weekly, monthly, or quarterly, doing this after each payment is a file smart move which can prevent accidental overspending.
If this all sounds too complicated, it may be best to turn your taxes over to a professional. Amanda M. Ferris, managing director of consulting and education firm Clover & Kind, warns, “Don’t do it yourself unless your experience is in small business accounting.” “Working with a qualified professional right from the start will help you avoid the stress, sleepless nights, and penalties that come with leaving taxes as an afterthought,” she explains.