Freelancers, Self-Employed, and Sole Proprietors! Find out how much tax will to pay, the penalty for not paying taxes owed.
I’m self-employed. How much tax will I pay?
If you’re a freelancer who considers themselves more right-brained than left-brained, knowing what you will have to pay in taxes might be the furthest thing from your mind. However, staying up on your tax obligations is the best way to prevent unpleasant interactions with the IRS down the road. Don’t worry, it’s not as overwhelming as you think. There are three categories of taxes you'll pay:
- Self-employment tax
- Federal income tax
- State income tax
When are my earnings subject to self-employment tax?
If you earn $400 or more from self-employment, you’ll need to file an income tax return for that business. That may seem like a surprisingly small amount, but the IRS counts self-employed income sources no matter how small.
What is included in self-employment tax?
The self-employment tax rate is 15.3%. This includes 12.4% for Social Security tax and 2.9% for Medicare tax. This percentage might seem higher than you remember it being as a W-2 employee. That’s because you’re now responsible for the percentage of Social Security and Medicare that your employer once paid for. As a self-employed person, you are responsible for the tax obligations of both employer and employee. You may know your former obligation as FICA as a salaried employee, which is the same as half of your self-employment obligation.
While the rate for self-employment is generally 15.3%, it’s important to note that as you earn more, there are some caps and changes to what you need to contribute. The 12.4% Social Security tax only applies to the first $142,800 you make per year (taking into account 2021 numbers). You may also incur an additional 0.9% in Medicare taxes if you hit a certain earnings threshold; for example, reaching $200,000 in earnings as a single filer.
You can estimate your self-employed taxes with a few details about your business.
What about quarterly taxes?
Most freelancers will also have to pay quarterly taxes - estimated payments based on what you anticipate owing for the year, generally paid evenly on a quarterly basis (although, some states, such as California, split up the percentages a bit differently). If you anticipate owing at least $1,000 in taxes over the course of the year, you should be making quarterly estimated payments to avoid a penalty at the end of the year.
State and federal income taxes
Your quarterly tax payments will include both self-employment tax and income tax. As a freelancer, you are responsible for paying income tax on your earnings. The rate you pay will depend on the amount you make for the year and the state you live in. For example, Florida, South Dakota, and Tennessee are all states without income tax.
When you’re just starting out, estimating what you will owe for the year can be tricky. Even after you’re established, your income can fluctuate significantly from year to year. However, you can use a tax calculator to get an estimate thorughout the year or downlod the Ruby Money App to fully automate your tax payments
Keeping track of deductions
In addition to your state and income level, your expenses will also impact what you owe in taxes.
The good news is that many of the expenses you incur to run your business are likely to be deemed deductible, as long as they are “ordinary and necessary.” This means things that would be seen as normal in your line of work to spend money on. For example, if you are a marketer, your expenses may include:
- SEO and analytics tools
- Bookkeeping software
- Social media management software
- Zoom licensing
- Office rentals or the use of a specific area of your home for business
- Equipment, such as a computer, camera, or lighting
- Mileage spent driving to and from meetings with clients
- Advertising to promote your business
- Professional services - accountants and lawyers
- Subscriptions - trade publications, news outlets
- Education & training
The more you are able to track expenses, the easier they will be to document and deduct. Don't forget that you can also deduct your SEP-IRA contributions.
Can I manage my taxes on my own?
Whether you enlist help to manage your taxes should depend on your abilities and your interest in investing the time to work on them. If you'd rather be doing something else with your time, or you're losing money spending time on taxes that could be replaced with income-earning activities, bringing in an accountant can be a good idea. Having someone on the outside look at your business can also give you a different perspective. They may have ideas as you move forward to lessen your tax obligations, or remind you of deductions you didn't think about.
Whether you work with an accountant or DIY your taxes, having a system for putting away what you owe can help you stay organized and on top of your finances from quarter to quarter. Ruby Money's platform allows you to allocate funds to taxes and retirement as your invoices come in, and can serve as the perfect complement, whether you're taking on your taxes yourself or bringing on help.