Freelance taxes explained: what you owe and how to not get surprised

Taxes are the single biggest surprise for new freelancers. As an employee, half your Social Security and Medicare taxes were paid by your employer. As a freelancer, you pay both halves. Here is what you need to know to avoid an expensive surprise.

The self-employment tax

The self-employment tax is 15.3% — 12.4% for Social Security and 2.9% for Medicare. If you earn $80,000 as a freelancer, you owe $12,240 in self-employment tax alone, on top of your income tax. Employees only pay half of this (7.65%). The other half was invisible to you.

You can deduct half of your self-employment tax from your income tax, which softens the blow but does not eliminate it.

Quarterly estimated payments

The IRS expects you to pay taxes as you earn income, not once a year. If you expect to owe more than $1,000 in taxes, you must make quarterly estimated payments. Due dates are April 15, June 15, September 15, and January 15.

Missing quarterly payments gets you hit with penalties and interest. The safe harbor rule: pay at least 100% of last year’s tax liability (110% if your income is over $150,000) and you avoid penalties regardless of what you actually owe.

How much to set aside

A general rule: save 30-40% of your freelance income for taxes. This covers:

• Self-employment tax (15.3%)
• Federal income tax (10-37% depending on bracket)
• State income tax (0-13.3% depending on state)

Open a separate savings account and transfer 30% of every payment into it. Do not touch this money except for taxes.

The biggest deductions

Your home office, health insurance premiums, retirement contributions (SEP IRA or Solo 401k), business equipment, vehicle mileage, software subscriptions, professional development, and half your self-employment tax are all deductible. These deductions reduce your taxable income significantly.

What happens if you cannot pay

The IRS offers payment plans. File your return on time even if you cannot pay. The failure-to-file penalty is 10x the failure-to-pay penalty. If you need more time to file, file an extension by April 15. This gives you until October 15 but does not extend the time to pay.

Use the Tax Deduction Finder to discover every deduction you qualify for, and work with the Rate Calculator to make sure your rates account for the tax burden.