Disclaimer: This resource is for informational purposes only and should not be construed as financial or tax advice (or a substitute for obtaining such advice), or for the purpose of avoiding U.S. Federal, State, or Local tax payments and penalties
We’ve put together this free guide to help you understand self-employment taxes in simple terms so you can nail tax season and start making tax planning a year round process.
TLDR; If you earned $400 or more in self employment profits this year, you likely have to pay self employment taxes. If you don't prepare in advance, you may be stuck with a large tax bill during tax season that you are unprepared to pay.
Here are the most critical things you should understand about self employment taxes:
- If you make money from gig work, freelancing, side hustles, or other self employment work, you likely have to pay taxes on this income. You are on the hook for calculating these taxes, and likely have to pay these taxes each quarter (called estimated taxes). If you are late or underpay your taxes, you might face a fine from the IRS.
- There are two ways you will be taxed on self employment earnings. 1. Self employment taxes, which are 15.3% and 2. Income tax on self employment income; the tax rate for this part is based on your income tax bracket.
- Taxes are based on business profits, so you'll need to keep track of your earnings and expenses to determine your tax bill. The better your recordkeeping, the more you can save through tax write-offs. If you use a car for self employment work, you may want to keep a record of your business mileage (commute miles don’t count).
- There are a few ways you can estimate and save for quarterly taxes. Some people do a high level estimate, like dividing last year’s self-employment taxes by four and paying that amount each quarter. Others simply save 20-30% of their earnings and hope that is enough. We recommend using software, such as the Level Financial Toolbox, to better estimate and save for your taxes.
- Come tax season, you will receive a 1099-NEC, 1099-K, or 1099-MISC form from anyone that paid you $600 or more as an independent contractor. These forms summarize how much you earned for self employment, and you are required to include this income on the Schedule C part of your tax return. 1099s are also sent to the IRS, so they will be able to tell if you are underreporting your income.
- If you work for a gig platform like Youtube, Amazon Mechanical Turk, Upwork, Lyft, Doordash, and TaskRabbit, expect to receive a 1099 form from them this year, even if you haven’t in the past. There were changes in the tax law this year that will require them to send out more forms than prior years.
Below we've expanded on key self employment tax concepts:
- How taxes differ for employees (W2) vs. self employed workers (1099)
- Responsibilities as a self-employed tax payer
- How much you can expect to pay in self employment taxes
- Ways to estimate your taxes and determine how much to save for IRS payments each quarter
- How to lower your tax bill
- The difference between a 1099-MISC, 1099-NEC, and 1090-K
- The impact that the American Rescue Plan Act had on tax reporting for independent contractors, gig workers, freelancers, and other self employed workers
If you are interested in learning more about how Level can help you navigate this tax season, please check out our Level Financial Toolbox page.
How are taxes different for employees (W2) vs. self employed workers (1099)?
As an employee (W2), your employer is responsible for withholding taxes from your paycheck and paying them to the government on your behalf. This means that your take-home pay is less than your salary because taxes have been deducted. Your employer is required to send you a W2 form each tax season, which summarizes your earnings and how much has been withheld.
On the other hand, if you are self-employed, you are responsible for paying your own taxes. This means that you need to calculate and pay your freelancer taxes yourself rather than having them withheld from your paycheck. Most self-employed people have to send in tax payments four times a year, called estimated tax payments. Come tax season, any business that paid you at least $600 as an independent contractor is required to send you a 1099-NEC, 1099-K, or 1099-MISC form that summarizes how much they paid you.
You may have heard of FICA taxes, which is a U.S. Federal Payroll tax that funds Social Security and Medicare. If you are a W2 employee, your employer pays for half of your FICA taxes, and the other half comes out of your paycheck. You'll notice on a W2 form that the social security tax is 6.2%, and the Medicare Tax is 1.45%, totaling 7.65% for your FICA Taxes. Your employer picks up the bill for the other 7.65%.
When you are earning self-employment income, however, you must pay the full FICA tax of 15.3%. This is in addition to the income tax (Federal and State) you will pay on these earnings. That can add up to a significant tax bill for many self-employed individuals.
Fortunately, self-employed individuals may be eligible for certain gig worker tax deductions that are not available to employees. For example, you may be able to write-off business expenses such as office supplies, travel expenses, and the cost of a home office.
What are my responsibilities as a self-employed tax payer?
Most people think of handling taxes as a once-a-year activity. But as a self-employed worker, proper tax planning should be a continuous journey. Spending just a little bit of your time each month on self-employment tax planning can save you from major headaches and financial stress during tax season.
Here are the activities you should perform as a self-employed person.
How much should I expect to pay in self-employment taxes?
Self-employed workers must generally pay taxes on self-employment income in addition to any other applicable individual income taxes. However, taxes apply to self-employment profits, not just earnings. This means you can subtract business-related expenses from your earnings, thus reducing your tax bill. Self-employed workers can determine their business's profit (or loss) for the year using Form 1040 Schedule C during tax season. There are two types of taxes that apply to self-employment profits: self-employment tax and income tax on profit or loss from a business.
1. Self-employment tax
Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the payroll taxes withheld from the pay of most wage earners. The self-employment tax rate is essentially 15.3% of your business profits.
2. Income tax on profit or loss from a business
On your tax return, self-employment profits (or loss) should be included alongside any income you earned from a W2 employer or other relevant sources. The tax rate you pay on income depends on your tax bracket. The more W2 or 1099 income you earn, the higher your income tax rate.
So how much should you expect to pay? The answer is it depends on your situation. No two taxpayers have the exact same situation, so it's hard to say, "If you earn $X in 1099 earnings, you should expect to pay $Y in freelancer taxes". However, below we've provided an example of a federal self employment tax calculation that may be helpful for you to get a sense of how things could play out. This example shows a taxpayer who expects to make $40,000 this year in rideshare earnings and an additional $15,000 in wages from working a part-time job at a local retailer. For this example, we also assume that they file as single, take the standard self-employed tax deduction, and expect no refundable credits for 2022.
Here are some key definitions to help you understand this example:
- Car mileage deduction: If you use the car for business, you may write off the cost of its business use. Typically, this is calculated by multiplying total business miles driven by the "standard mileage rate," a rate the IRS sets every quarter (62.5¢ per mile in this example)
- Adjusted gross income: Adjusted gross income is used by the IRS to determine how much income taxes you owe. Adjusted gross income includes your wages, investment income, business income, and other income. Adjustments to income include such items as Educator expenses, Student loan interest, Alimony payments or contributions to a retirement account.
- Deduction for self-employment (S.E.) tax: You can deduct 50% of your self-employment tax when calculating your adjusted gross income. This freelancer tax deduction only affects your income tax, not your self-employment tax.
- Standard deduction: The standard deduction is a dollar amount set annually by the IRS that most taxpayers can deduct from their taxable income to reduce their tax bill.
- Qualified business income deduction: The qualified business income deduction (QBI) allows eligible self-employed workers to deduct up to 20% of their business income on their self-employment taxes.
- Taxes withheld by W2 employer: This represents the portion of wages that an employer withheld from paychecks to pay for income taxes on W2 earnings.
Depending on which state you reside in, you may also owe state taxes on self employment income. As you can see, self-employment taxes can add up.
How do I estimate my own taxes and determine how much to save for IRS payments each quarter?
Estimating your self-employment taxes is important because it allows you to budget for the self-employment taxes you will owe. If you do not pay your self-employment taxes on time, you may be subject to penalties and interest charges from the IRS. To pay your gig worker taxes online or for more information, go to IRS.gov/Payments.
There are a few ways to estimate your self-employment taxes, depending on how accurate you’d like to be.
Option 1: Use tax planning software
Tax planning software can provide a great balance of accuracy and affordability for most self-employed individuals. The software can provide you with an easy and highly accurate way to estimate your freelancer taxes, as well as track income and expenses for tax write-off purposes.
If you are unsure what your earnings and expenses will be for the year, tax software provides a great solution to help prepare for different scenarios. This is especially helpful for first-time self-employment taxpayers, who may not have a prior-year tax return to compare to.
Level offers a comprehensive suite of tax planning tools for self-employed individuals that is perfect for both new taxpayers and seasoned self-employed workers. Level's software reviews a worker's financial history and tax profile to estimate their yearly and quarterly tax obligations, preventing year-end scrambling and surprises. Level can even recommend a tax savings rate based on your situation and automatically transfer money from your 1099 earnings into a separate savings account, essentially putting your self-employment taxes on autopilot! Level offers all the freelancer tax help you need to comply with tax laws no matter where you are.
Option 2: Calculate manually using the IRS-provided forms
Estimated taxes can be calculated using Form 1040-ES. Self-employment taxes are calculated based on your self-employment profit (earnings minus business expenses), so it is important to have an accurate estimate of this amount to ensure that you are paying the correct amount of taxes. When figuring out your estimated tax for the current year, it may be helpful to use your income, self-employed tax deductions, and credits for the prior year’s tax return as a starting point.
If this is your first year paying freelancer taxes, you should make your best guess about what adjusted gross income you will make this year and what freelancer tax deductions/credits you will be eligible for.
It’s important to note that many people find using Form 1040-ES not very straightforward. The form contains several pages of instructions that can be hard to follow, and the form itself does not make calculations for you.
Option 3: Make a high-level estimate
If you’ve paid self-employment taxes before, one simple way of estimating this year’s taxes is to look at what you paid last year as a starting point. If you think your financial situation will be very similar this year, it may be ok for you to simply divide last year’s self-employment taxes by four and aim to save that much to pay the IRS each quarter. Generally, most taxpayers will avoid an underpayment penalty if they paid at least 100% of the tax shown on the return for the prior year.
However, if you end up with a different amount of W2 or 1099 income than last year, or your tax profile has a dramatic change (e.g., filing status, tax credit eligibility), you could wind up over or underpaying each quarter.
If this is the first year you are paying self-employment tax, many sites claim a good “rule of thumb” is to save between 20-30% of each paycheck towards taxes. However, it is better to use a more precise method (see options 1 and 2 above) to make sure you are saving the right amount.
Even if you do a high level estimate, it is still critical to keep quality records of your business expenses in order to maximize your write-offs during year end tax filing.
Option 4: Hire a professional accountant
If you run a small business, hiring an accountant may be appropriate. Some self-employed workers hire accountants on a part-time basis to help them plan for freelancer taxes and/or navigate tax season. However, accountants can charge hundreds of dollars a month for their services, and typically the cheaper alternatives outlined above can be just as effective and convenient, especially if you are a one-person microbusiness or gig worker.
How can I lower my tax bill?
Self-employment taxes are calculated based on business profit, not 1099 earnings. This means that the total amount of business expenses you claim can have a huge impact on your freelancer tax bill.
You can deduct many expenses that are directly related to your self-employment income. The most common expenses faced by self-employed workers are
- Auto expenses, including gas, repairs, parking, tolls, interest payments, and more
- Home office expenses, including rent, internet, computers, and phone bills
- Supplies, including tools, materials, or other items required for a job
- Other travel expenses, including airfare, accommodations, and meals related to business trips
The IRS requires self-employed customers to keep records of these transactions and may audit you. You should keep quality records of your day-to-day business expenses, large business purchases such as cars or computers that you can depreciate, and business auto mileage. These records can significantly lower your tax bill.
Level’s Financial Toolbox includes a full set of features to help you find all the self-employed tax deductions you qualify for. It can even connect your financial accounts to automatically identify expenses that are likely related to your self-employment. When it comes time to file, Level can automatically generate a Schedule C form to make self-employment tax filing a breeze.
1099-MISC, 1099-NEC, 1090-K, what are these?
A 1099-NEC, 1099-K, and 1099-MISC are all IRS forms that businesses used to report payments they made throughout the year. Business send these forms to the Internal Revenue Service (IRS), and anyone receiving these payments will also receive a form and is required to report this income on their tax return. These three forms are used for different types of payments:
What is a 1099-NEC?
A 1099-NEC, or Nonemployee Compensation, is used to report income paid to a person or business that is not an employee. This might include income paid to independent contractors or freelance workers. If you work for a gig platform this is likely the form you will receive.
What is a 1099-K?
A 1099-K, or Payment Card and Third Party Network Transactions, is used to report income received through payment card transactions or third-party network transactions. This might include income received through credit card payments or transactions made through a payment processing service. So if you were paid for gig work, a side hustle, or freelancing through apps like Venmo, Square, PayPal, or Amazon, you may receive a 1099-K in January.
What is a 1099-MISC?
A 1099-MISC, or Miscellaneous Income, is used to report income from sources other than wages, salaries, and tips. This might include income from rent, royalties, or awards. Previously, companies reported payments for nonemployee compensation on Form 1099-MISC, but the 1099-NEC is now the standard form.
What is different for self employed workers this tax season?
The American Rescue Plan of 2021 changed the reporting threshold for 1099s. The new rule states that any business that paid you at least $600 as an independent contractor is required to report these payments to the IRS via 1099 forms. In the past, businesses were only required to file 1099s for workers that were paid over $20,000 in a year. This represents a large change in the tax landscape, with many self-employed people having to deal with these gig worker taxes for the first time.
However in December, the IRS announced that it is delaying the enforcement of this change until next tax season (2023-2024). It is unclear which organizations will still choose to send 1099s for payments less than $20,000.