How much should I set aside for taxes?

Are you self-employed and wondering, “How much should I set aside for taxes?” It’s a crucial question! Taxes can be a bit of a headache, but understanding how to prepare for them is essential for your financial peace of mind. As a freelancer or small business owner, you don’t have an employer withholding taxes from your paycheck. That means you’re responsible for managing and paying them yourself. Failing to set aside enough can lead to an unexpected tax bill and potential penalties come tax season.

But don’t worry, we’re here to help! This guide breaks down everything you need to know about setting aside money for taxes as a self-employed individual.

UNDERSTANDING SELF-EMPLOYMENT TAXES

First things first, let’s clarify what self-employment taxes actually are. When you’re self-employed, you’re responsible for paying both the employee and employer portions of Social Security and Medicare taxes. These are combined into what’s known as self-employment tax.

The self-employment tax rate is currently 15.3%. This consists of 12.4% for Social Security and 2.9% for Medicare. This is applied to your net earnings from self-employment. Remember, this is separate from your regular income tax.

CALCULATING ESTIMATED TAXES

Now that you understand self-employment taxes, let’s figure out how to calculate how much you’ll owe. This involves estimating your income and expenses for the year.

Here’s a simplified breakdown:

1. Estimate your annual income: Consider your past income, current projects, and projected earnings for the year.
2. Estimate your business expenses: Include all eligible business expenses, such as office supplies, software subscriptions, and travel costs.
3. Calculate your net income: Subtract your expenses from your income.
4. Determine your self-employment tax: Multiply your net income by the self-employment tax rate (15.3%).
5. Estimate your income tax: Use the IRS tax tables or a tax calculator to estimate your income tax liability based on your estimated net income.
6. Add self-employment and income taxes: This gives you your total estimated tax liability for the year.

Keep in mind that this is just an estimate. Your actual tax liability may vary depending on your income and expenses throughout the year.

HOW MUCH SHOULD I SET ASIDE FOR TAXES SELF EMPLOYED?

This is the big question, isn’t it? How much should you actually set aside for taxes? It’s not a one-size-fits-all answer, unfortunately. Income tax rates vary between states, so it’s essential to look up the specific rates for your state. To make things a little more complex, the tax rate also changes based on your income level and other factors. Federal tax rates range from 10% up to 37%, depending on your income.

But here’s the good news: one of the best things about being self-employed is tax deductions! You can deduct eligible business expenses, which reduces your taxable income and, ultimately, your tax bill. This is why it’s so important to keep accurate records of all your expenses throughout the year.

Here are some common deductions you might be able to take:

• Home Office Expenses: If you have a dedicated workspace at home, you can deduct a portion of your rent or mortgage interest, utilities, and other home-related costs. This can be a significant deduction if you work from home regularly.
• Business Expenses: This covers a wide range of costs directly tied to your business, such as office supplies, software subscriptions (like Houzzpro or QBO!), marketing, and travel. Be sure to keep receipts and track all your business expenses to maximize your deductions.
• Retirement Contributions: Saving for retirement is always a good idea, and it can also help you save on taxes! Contributions to self-employed retirement plans, like a SEP IRA or Solo 401(k), are tax-deductible.
• Health Insurance Premiums: As a self-employed individual, you can generally deduct your health insurance premiums. This can be a valuable deduction, especially if you’re paying for your own health insurance.
  

Remember: Tax is calculated on your profit, not your total revenue. So, those deductions can make a real difference in how much you owe! Be sure to take advantage of all the deductions you’re eligible for to minimize your tax liability.

SAVING STRATEGIES FOR TAXES

Wondering where and how to stash that cash? Maybe you’re even asking yourself, “Should I keep my tax money in the bank?” Let’s look at some smart saving strategies to help you stay organized and avoid any surprises come tax season:

• Separate Savings Account: It’s wise to keep your tax money separate from your everyday business funds. Opening a dedicated business savings account just for taxes can prevent accidental spending and even earn you a bit of interest! This way, you’ll have a clear picture of how much you’ve saved and won’t be tempted to dip into it for non-tax-related expenses.
• Automatic Transfers: Want to make saving for taxes even easier? Set up automatic transfers from your business checking account to your tax savings account. This way, you’ll consistently set aside money without even having to think about it. Just be sure to adjust the transfer amount if your income changes significantly.
• Budgeting: Don’t forget to include tax savings as a line item in your budget. This will help you track your progress and stay on top of your savings goals. You can use a budgeting app, spreadsheet, or even a good old-fashioned notebook to keep track of your income and expenses, including your tax savings.

WHEN DO I PAY MY BUSINESS TAXES?

As a self-employed individual, you’ll usually need to make estimated tax payments quarterly. These payments are due on specific dates throughout the year:

• 1st Quarter: April 15th
• 2nd Quarter: June 15th
• 3rd Quarter: September 15th
• 4th Quarter: January 15th of the following year

You can make these payments online, by mail, or by phone. It’s important to pay your estimated taxes on time to avoid penalties.

WHAT HAPPENS IF I DON’T SAVE ENOUGH AND END UP PAYING TAX LATE?

It’s a common worry. What if you don’t save enough and end up having to pay your taxes late? Well, the IRS does have penalties for underpayment, but there’s also some good news. There’s a “safe harbor” rule that can protect you from these penalties.

You’re generally safe from underpayment penalties if:

• You pay at least 90% of the tax you owe for the current year, or
• You pay 100% of the tax you owed for the previous tax year, or
• You owe less than $1,000 in tax after subtracting withholdings and credits.

However, there’s an exception to this rule. If your previous year’s tax return showed income over $150,000, you’ll need to pay the smaller of these two amounts:

• 90% of the current year’s tax, or
• 110% of the previous year’s tax.

If you don’t meet any of these safe harbor conditions, you’ll likely face a penalty. This is usually around 0.5% of the unpaid amount each month or part of a month that the taxes remain unpaid, but it can go up to 25%.

TAX PLANNING STRATEGIES

Proactive tax planning can help you minimize your tax liability and maximize your savings. Here are a few strategies to consider:

• Retirement contributions: Contribute to tax-advantaged retirement accounts to reduce your taxable income and save for the future.
• Tax-loss harvesting: If you have investments that have lost value, you may be able to sell them to offset capital gains and reduce your tax liability.
• Tax credits: Research available tax credits for self-employed individuals, such as the child tax credit or earned income tax credit.

Working with a tax professional can provide personalized guidance on tax planning strategies tailored to your specific situation. Our CFO services can help you develop a comprehensive tax plan that aligns with your business goals.

Remember, staying on top of your taxes is crucial for your financial well-being as a self-employed individual. By understanding the basics, planning ahead, and seeking professional help when needed, you can confidently manage your tax obligations and focus on what you do best – running your business! Contact us today.

FAQs