It is believed that between 7% and 10% of all workers in America are independent contractors.
Whether you are freelancing as your full-time job or as a side-gig, being self-employed can make paying taxes more complicated.
How are you supposed to know how much to set aside for taxes?
Let's take a look at what you should know about planning for taxes as an independent contractor.
What Is an Independent Contractor?
When you work as an independent contractor, you are working for someone else but not as their employee. You are therefore considered self-employed because you are running your own business and taking someone on as a client rather than working for an employer.
When you work as an employee, someone else determines what will be done and the way it will be done. When you're an independent contractor, you're hired for specific work and paid based on the resulting work.
Types of Independent Contractor Jobs
There are a lot of different occupations that could lead to you filling out 1099 taxes.
Tradespeople are frequently independent contractors. This could mean painters, carpenters, plumbers, electricians, bricklayers, wedding planners, hairstylists, mechanics, and many more.
Consultants are another group of occupations that are often independent contractors. This refers to advisers in any sector of the economy such as financial, legal, health care, or personal services.
People who work as artists will often also pay taxes as independent contractors. Whether they are musicians, photographers, writers, sculptors, glass cutters, or woodworkers, they are seen as having and running their own business.
People who work in the gig economy are also frequently going to file independent contractor taxes. No matter what job you work, it is important to understand whether or not you're an employee or a sole proprietor, as it impacts how much you pay in taxes.
What Is a Sole Proprietor?
A sole proprietor is a business with a single-owner that isn't a corporation. If you are an independent contractor, you will be considered a sole proprietor when it comes time to pay your income taxes.
Does Being an Independent Contractor Affect My Pay?
When you are an independent contractor, you still get paid for your work but not in wages or a salary. Rather, your payments are taken out of the business's income. When you get paid for your work, the money goes into a business checking account.
Since you are an owner and not an employee, you can take money out in the form of a "draw" but not in the form of a salary. You must pay taxes on all of the money you make, it doesn't matter how much you draw out of this account.
Since you aren't an employee of another company, taxes haven't been deducted out of the money you receive for your work. Whereas for another job you might even get a tax refund come tax time, as a freelancer you're responsible for paying your own self-employment taxes.
Saving for Taxes as an Independent Contractor
The best way to save taxes for freelancers is to actually have the IRS do it for you. Every three months, you should be sending estimated quarterly payments to the IRS. This way, you're basically paying your taxes as the year goes along, the same way you would if you were employed by a company.
The IRS can apply penalties if you don't pay quarterly taxes by the due dates each year. Paying quarterly also avoids having a big terrible surprise once a year come tax seasons.
How Much to Set Aside For Taxes as a Freelancer?
The recommended percentage to set aside for independent contractor taxes is 25-30% of your income. If this sounds high, it is because you're paying self-employment tax on top of income tax. The self-employment tax is the FICA taxes, which is the Social Security and Medicare normally withheld from your paycheck.
When you are employed, you are only responsible for half of these FICA taxes while your employer is responsible for the other half. When you work for yourself, you've got to fit the whole bill.
How to Calculate Your Income
While this all might sound like a lot, don't forget that you can deduct the costs associated with running your business from your freelance taxes. When tax time rolls around, you will fill out a Schedule C form that documents your business expenses. You will be able to subtract your deductible expenses from your income, leaving you with your taxable income.
The best way to do this is to keep track of your deductible expenses as the year goes on. Things that are deductible include travel expenses, office supplies, maintaining an office, and miles driven for business purposes.
If this is only your first year freelancing, you will have to estimate taxes. It is best to estimate your income on the low side rather than too high with the IRS, but you can always make an adjustment the following quarter or year.
Are you employed after all? Check out this salary calculator.
How Much to Set Aside For Taxes: Final Thoughts
There are a lot of advantages to working as an independent contractor as well as a lot of disadvantages. The tax situation is definitely on the 'cons' side of the list.
If you value being your own boss and being in control of your own schedule, however, dealing with slightly more complicated and more expensive taxes can be worth it. It is just important that you understand how freelance taxes differ from employee taxes so that you aren't caught by surprise come tax season.
Did you find this article about how much to set aside for taxes helpful? If so, be sure to check out the rest of our blog for more useful and informative articles!
