How to budget for taxes as a freelancer and avoid a costly tax bill

How to budget for taxes as a freelancer and avoid a costly tax bill

The prospect of making money on your own terms can be exciting, but many freelancers underestimate their tax obligations.

Laurice Wardini, freelance writer and co-founder of ClothedUp, says, “I knew taxes would be expensive when I started freelancing, but I was shocked when it came time to pay them.” She adds, “I didn’t prepare well and had to pay a huge bill at the end of the year.”

To avoid unpleasant surprises, the self-employed must keep an eye on their tax debts throughout the year. If you’re not sure where to start, here’s an overview of how taxes for freelancers work and how much you should set aside.

How Taxes Work for Freelancers

Once you become self-employed, the first thing you need to know is that your taxes are double. You will likely have to pay self-employment tax in addition to income tax.

If you earn at least $400 in net income as a self-employed person, the Internal Revenue Service requires you to case Attach SE and pay a 15.3% self-employment tax. Of the 15.3% tax rate, 12.4% goes to Social Security and 2.9% to Medicare. That said, you won’t have to pay the Social Security portion of the income tax that exceeds the program’s annual income cap ($147,000 for 2022).

Individuals can deduct half of the employer’s self-employment tax when calculating their adjusted gross income. This will help reduce the amount of income tax due. However, this will not reduce net self-employment earnings or self-employment tax.

Then, income taxes are levied on the net adjusted gross income of businesses and individuals. As a freelancer, you may be responsible for federal, state, and regional taxes. Here’s a bit more about each:

  • Federal income tax rates are progressive and currently range from 10% to 37% for 2022. You will likely pay several rates that increase as your income increases.
  • Forty-one states levy income taxes with variable rates. The nine that are not are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
  • Regional income taxes are less common, but they exist in a handful of states. They are most often levied by cities, but can also be levied by counties, school districts, or special districts.

Your tax obligations will depend on where you live, your tax status and your income. For this reason, you will need to do some research to determine what you need. Typically, you can find published income tax laws and rates on state and regional government websites.

When do the self-employed 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 the 2022 tax year, the payment deadlines are as follows:

  • A quarter: Due April 18, 2022.
  • Second trimester: Due June 15, 2022.
  • Trimester three: Due September 15, 2022.
  • quarter four: Due January 17, 2023.

To avoid tax penalties, it is important to make your estimated payments on time and according to your best estimate of the amounts due.

How much should freelancers set aside for taxes?

If you are a freelancer earning at least $400 in net income, you will need to set aside 15.3% of your net income for self-employment tax and enough to cover your income taxes.

To determine how much to set aside for income tax, check the tax rates that apply to you at the federal, state, and regional levels. Count them along with the self-employment tax to get the total percentage you’ll set aside.

For example, Andrew Marshall, an Independent Certified Financial Planner, says, “I set aside 30% because I live in California and my self-employment tax, as well as state income taxes and from the federal government, make up just under a third of my income.”

Tax planning tips for freelancers

Once you know how much to set aside, how do you save it? Marshall advises, “Every time a customer pays me, I transfer 30% of their payment to my tax savings account. Then I pay my estimated taxes each quarter using that money. »

Although you can also set aside your estimated taxes weekly, monthly or quarterly, doing so after each payment is a smart move that can prevent accidental overspending.

If all of this seems too complicated, it may be best to entrust your taxes to a professional. Amanda M. Ferris, chief executive of consulting and education firm Clover & Kind, cautions, “Don’t tinker unless your expertise is in small business accounting.” She explains, “Working with a trained professional early on will help you avoid the stress, sleepless nights, and penalties that come with not paying taxes after the fact. »

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