Account for US taxes–they’re your responsibility now

There’s one more major expense you need to account for if you live or work in the United States: taxes. When you work for a company, taxes are automatically withheld from your paycheck. When you’re self-employed, you’re responsible for setting aside money for your taxes. 

Building a tax buffer into your financial plan and understanding how taxes work will help you avoid a big tax bill and can soften the blow of any unexpected expenses. 

Understand freelance taxes 

If you earn any income doing freelancing or contract work, you’ll have to set aside money yourself to pay for the taxes you’ll owe the government. 

You’ll have to make quarterly payments to the IRS in the form of estimated tax payments. It’s important to accurately estimate how much money you expect to pay in income taxes. We suggest setting aside 25-30% of your freelance income to cover the taxes. You may want to open a separate savings account to stay organized, but we'll get to this in step 7.

One upside of freelancing is that you’re typically able to take a number of deductions, meaning you can subtract the price of these from your taxable income and lower the amount of taxes you owe. Common deductions include:

• Office supplies.

• Computer equipment and software.

• Advertising and marketing.

• Home office deduction.

• Utilities.

Typically, your income will vary throughout the year, which may mean your quarterly estimated tax payments are different amounts. That’s why estimated taxes are just that — estimates. If you underpay your estimated taxes, you’ll have to pay the remaining taxes when you file your annual return. Likewise, if you pay too much, you’ll get the extra back.

If you don't plan accordingly, you could find yourself with a large bill when tax season arrives. Not only will you be charged taxes on any income earned throughout the year, but there may also be additional fees involved if you haven't been keeping up with your payments. 

Calculate the taxes you should set aside

The simple way to calculate how much to factor in is to multiply your minimum income goal by 25%. For example, if your minimum annual income is $50,000, you would add $12,500 in taxes to get an income of $62,500. 

In the workbook, we’ve included a calculator that will do it for you. But in the next section, we walk you through how you can be more precise if you’re interested.

If you’re interested in finding a more exact figure, here’s what you need to do:

1. Figure out your tax filing status, which will help determine how large your standard deduction is. You’re considered “single” if you’re filing taxes independently of anyone else (this includes if you're married, but filing separately). If you’re a sole proprietorship or a single-member LLC, you’re also considered “single.” 

2. Use the income figures in the last step to calculate your income tax. This can be a little tricky, as the federal government uses income brackets to determine how much you owe. You can either calculate your federal tax yourself by using the IRS’ tax rate brackets or use an online calculator like this one. 

3. You also need to factor in state income taxes. Some states don’t have income tax, some use a flat income tax, while others use a graduated-rate income tax. You can find your state’s income tax here. 

4. Add your expected federal income tax and state income tax together to get the total amount of taxes you’ll likely owe. 

You’ll have to calculate your taxes twice, once for your minimum salary and once for your ideal salary. Once you figure out how much tax you’re likely to owe, you can understand exactly how much you need to bring in, in order to pay yourself the salary you desire and cover your quarterly taxes.

Minimum salary + Tax burden = Minimum amount you need to make to freelance full-time 

$50,359 + $15,108 = $65,467 (rounded to the nearest dollar)

Ideal salary + Tax burden = Ideal amount you need to make to freelance full-time and be able to afford all your "nice to haves"

$57,479 +$17,244 = $74,723 (rounded to the nearest dollar)

Recap

• Discovered why building a tax buffer can help mitigate any large tax bills.

• Calculated the minimum amount you need to make to freelance full-time, accounting for taxes.

• Calculated the ideal amount you want to make freelancing full-time, accounting for taxes.