As a freelancer, you'll need to be sure to set aside a percentage of your business revenue for taxes. And while paying self-employment and estimated taxes when you freelance are a given, the exact percentage you should set aside can be tricky. If you don't save enough for freelance taxes, you could be left in a pinch financially when it's time to pay Uncle Sam.
While there’s no “magic number” that all freelancers should go by, there are a few ways to figure out how much you should budget for your taxes. Here’s how to go about it.
No matter what your individual tax rate is, you’re responsible for paying self-employment taxes. This is known as your FICA, which stands for the Federal Insurance Contributions Act, and is made up of your Social Security tax and Medicare tax.
When you work for someone, 6.2 percent of your gross income goes toward your Social Security tax, and 1.45 percent toward your Medicare tax. Your employer would match this amount, adding up to 15.3 percent.
But when you are self-employed, you'll be responsible for paying the entirety of that 15.3 percent yourself — you're both the employer and employee in this scenario. This FICA makes up the bulk of taxes you'll owe as a freelancer.
Calculating Your Freelance Taxes
Besides paying FICA, you’ll need to pay additional percentages of your income. These percentages are based on your tax bracket, whether or not you have to pay state income tax and your filing status, explains Tai Stewart of Saidia Financial Solutions, a full-service accounting firm that specializes in taxes for entrepreneurs and small businesses.
“You're only paying tax on the income,” says Stewart. “That is, the profit you made after all business expenses are deducted from your gross revenue.” She suggests that freelancers run a profit and loss report every month or every quarter to calculate how much income they actually made. This actual income is the amount to base your tax withholding on.
While those who have day jobs pay taxes on their individual returns once a year, when you’re a freelancer you need to pay estimated taxes. These are taxes you pay on income that isn’t subject to withholding (since your "paychecks" don't come from an outside employer). You may receive 1099 forms from your larger clients, which can help you document earned income. Note that if you earn less than $1,000 as a freelancer, you typically don’t need to pay estimated taxes.
Your estimated taxes are due at both the federal and state level, and typically must be paid quarterly: January 15, April 15, June 15, and September 15.
Budgeting for Taxes
Once you’ve estimated how much you need to set aside from your income for taxes, be sure to save that amount from every payment you receive from clients. It’s common advice that freelancers save 30 percent of their total income for taxes, points out Katherine Pomerantz, founder of The Bookkeeping Artist.
There are a handful of apps and digital banks that allow you to save a percentage of every paycheck you receive. That will save you the trouble of remembering to manually transfer funds into your bank account — or being tempted to spend some of your income that should go toward your freelance taxes.
Lower Your Freelance Taxes
While Pomerantz says you should "absolutely" save at least 30 percent of your income, she also adds: "If you actually owe 30 percent of your total income in taxes, then your tax strategy needs work." She explains that by staying on top of your bookkeeping to maximize deductions and using the right mix of retirement accounts, you could end up paying 15 percent of your total revenue (or less) in taxes.
“Saving for retirement can seem like a pipe dream when you're a freelancer, but this is the biggest tax deduction I see freelancers miss out on,” says Pomerantz. “Any contribution to a Traditional or SEP IRA is tax deductible.”
While you should still aim to save a full 30 percent of your income, instead of sending it straight to the government, Pomerantz recommends using savvy tax strategies to put it in a retirement account and pay no tax.
“In 2019, you can save $6,000 in a Traditional IRA and whopping $56,000 in a SEP IRA,” she says. “You can contribute to both, and take up to $62,000 off your taxes.”
If you have any questions on how to budget for freelance taxes when you’re self-employed, Incfile can help. Our team of tax professionals can help prepare your business taxes as well.