As a self-employed individual, you’re responsible for paying both the employee and employer portions of Social Security and Medicare taxes, known as self-employment taxes. These taxes are calculated at a rate of 15.3% on your net income, which is your total income minus any allowable business deductions.
To ensure you have sufficient funds to cover your tax liability, it’s advisable to set aside a portion of your income specifically for taxes. The amount you should set aside will depend on your individual circumstances, including your income level, tax deductions, and estimated quarterly tax payments.
Recommended Savings Percentage
As a general rule of thumb, it’s recommended to save around 25-30% of your self-employment income for taxes. This percentage takes into account both the self-employment tax rate and the potential for additional income taxes, depending on your income level and tax bracket.
Factors Affecting Tax Liability
The amount of taxes you owe will vary based on several factors, including:
- Net income: The higher your net income, the more taxes you’ll owe.
- Tax deductions: Business expenses and other allowable deductions can reduce your taxable income, thereby lowering your tax liability.
- Tax credits: Certain tax credits, such as the earned income tax credit or child tax credit, can further reduce your tax bill.
- Estimated quarterly tax payments: If you expect to owe more than $1,000 in taxes when you file your annual return, you’ll need to make estimated quarterly tax payments throughout the year.
Calculating Your Estimated Tax Liability
To estimate your self-employment tax liability, you can use the following formula:
Estimated Tax Liability = Net Income x 15.3%For example, if your net income is $50,000, your estimated tax liability would be $50,000 x 15.3% = $7,650.
Setting Aside Funds for Taxes
Once you’ve estimated your tax liability, you should set aside a portion of your income each month or quarter to cover your tax payments. You can do this by:
- Setting up a separate savings account: Dedicate a specific savings account to hold funds for taxes.
- Automating transfers: Set up automatic transfers from your business checking account to your tax savings account on a regular basis.
- Using a tax payment service: There are online services that can help you calculate and pay your estimated quarterly taxes.
Additional Considerations
- State income taxes: In addition to federal self-employment taxes, you may also be responsible for paying state income taxes. The rules and rates for state income taxes vary by state.
- Estimated quarterly tax payments: If you expect to owe more than $1,000 in taxes when you file your annual return, you’ll need to make estimated quarterly tax payments. These payments are due on April 15, June 15, September 15, and January 15 of the following year.
- Penalties for underpayment: If you underpay your estimated quarterly taxes, you may be subject to penalties. To avoid penalties, make sure to set aside sufficient funds for taxes and make your estimated payments on time.
Setting aside funds for self-employment taxes is crucial to ensure you have the necessary resources to cover your tax liability. By following the recommendations outlined above, you can estimate your tax liability, determine an appropriate savings percentage, and implement strategies to set aside funds for taxes. This proactive approach will help you avoid unexpected tax bills and potential penalties.
How The Self Employment Tax Works (And How You Can Avoid It!)
FAQ
How much self-employment tax should I set aside?
How much should you withhold for taxes if you are self-employed?
What percentage should a self-employed person save for taxes?
How do I calculate taxes for self-employed?
How much self-employment tax do you pay?
Only 92.35% of your total net earnings are subject to self-employment tax. This is known as your tax base. For example, let’s say you’re single and your 2022 self-employment net earnings come out to $50,000. Here’s how you’d calculate your self-employment taxes: Determine your self-employment tax base.
How do you calculate self-employment tax?
Determine your self-employment tax base. Multiply your net earnings by 92.35% (0.9235) to get your tax base: $50,000 x 92.35% = $46,175 Calculate your self-employment tax. Multiply your tax base by the self-employed tax rate: $46,175 x 15.3% (0.153) = $7,064.78. There’s no additional Medicare tax because your net earnings fall under $200,000.
Can you deduct self-employment tax on income taxes?
You can deduct 50% of your self-employment tax on your income taxes. You may need to pay self-employment tax if you’re a freelancer, an independent contractor or a small-business owner. Here’s what self-employment tax is, how it works and how you can save.
How does self-employment tax work?
The tax is divided into two parts: 12.4% goes to Social Security, and 2.9% goes to Medicare. Unlike income tax, self-employment taxes only get applied to your business income. Meaning, income that’s reported on a Form 1099. You can read more about how this tax works in our beginner’s guide to self-employment tax.