How Much to Put Away for Taxes When Self-Employed
Navigate self-employment taxes with confidence. Discover how much to save and when to make your estimated payments.
Self-employment offers independence but shifts the entire tax responsibility to the individual, unlike traditional employment where taxes are withheld from each paycheck. Understanding these tax obligations and proactively saving for them is an important aspect of managing personal finances as a self-employed individual. This preparation helps to avoid unexpected tax bills and potential penalties.
Types of Self-Employment Taxes
Self-employed individuals primarily face two types of federal taxes: income tax and Self-Employment (SE) tax. Federal income tax applies to net earnings from self-employment, similar to how it applies to wages. SE tax is a mandatory contribution to Social Security and Medicare.
For 2024, the Social Security portion is 12.4% on net earnings up to $168,600. The Medicare portion is 2.9% on all net earnings, with an additional 0.9% Medicare tax applying to net earnings exceeding certain thresholds, such as $200,000 for single filers or $250,000 for those married filing jointly. Self-employed individuals may also be responsible for state and local income taxes, depending on where they live and operate their business.
Estimating Your Business Finances
Estimating business finances is a key step before calculating tax liability. This involves projecting gross income from all self-employment activities for the tax year. It is important to identify and track all deductible business expenses, as these reduce the amount of income subject to tax.
Common deductible expenses include home office expenses, office supplies, and business-related travel. For instance, the standard mileage rate for business use of a vehicle is 67 cents per mile for 2024. Other deductions include professional development costs, health insurance premiums, and the Qualified Business Income (QBI) deduction, which allows eligible individuals to deduct up to 20% of their qualified business income. Maintaining accurate records of all income and expenses throughout the year is important for substantiating these estimates and deductions.
Determining Your Tax Amount
Once gross income and deductible expenses are estimated, the next step is to calculate the projected tax liability. First, determine net earnings from self-employment by subtracting business expenses from gross income. Note that 92.35% of these net earnings are subject to Self-Employment (SE) tax, as a portion of self-employment tax is deductible.
To calculate the SE tax, apply the 12.4% Social Security tax rate to the portion of the 92.35% net earnings that falls within the Social Security wage base limit ($168,600 for 2024). Then, apply the 2.9% Medicare tax rate to the entire 92.35% of net earnings. The total of these two components is the estimated SE tax. For federal income tax, one-half of the calculated SE tax can be deducted from gross income, which helps reduce taxable income.
After determining adjusted gross income, apply either the standard deduction or itemized deductions, whichever results in a lower taxable income. For 2024, standard deduction amounts are $14,600 for single filers, $29,200 for married filing jointly, and $21,900 for heads of household.
Taxpayers may also qualify for various tax credits, such as the Child Tax Credit (up to $2,000 per qualifying child for 2024, with up to $1,700 being refundable) or education credits. Finally, apply the appropriate federal income tax brackets to the remaining taxable income to estimate the federal income tax. State and local income taxes also need to be factored into the overall estimate if applicable.
Making Estimated Tax Payments and Saving
Self-employed individuals are generally required to pay estimated taxes throughout the year if they expect to owe at least $1,000 in tax. The tax year is divided into four payment periods, with specific due dates: April 15, June 15, September 15, and January 15 of the following year. If a due date falls on a weekend or holiday, the deadline shifts to the next business day.
To ensure funds are available for these payments, setting aside a portion of income regularly is a common practice. This can involve establishing a separate savings account for taxes and automating transfers from a business checking account. The Internal Revenue Service (IRS) offers several convenient methods for making estimated tax payments, including IRS Direct Pay and the Electronic Federal Tax Payment System (EFTPS). Payments can also be made by mail using Form 1040-ES payment vouchers.
Underpayment penalties can apply if insufficient tax is paid throughout the year. To avoid these penalties, taxpayers typically need to pay at least 90% of their current year’s tax liability or 100% of their prior year’s tax liability through estimated payments. For higher-income taxpayers, this prior-year safe harbor increases to 110%. If income fluctuates, taxpayers can adjust their estimated payments each quarter using IRS Form 1040-ES or annualize their income to potentially reduce or avoid penalties.