Adjust for US taxes

Unfortunately, you can’t escape taxes, even as a freelancer. Building a tax buffer into your income goal ahead of time is important because:‍

• It avoids any negative surprises come tax time (aka a big tax bill) 

• It builds a buffer in case any other unexpected expenses come up 

Of course, you may not know how much you’re going to make down to the dollar, but having a rough estimate of how much you may owe in taxes will help you better plan and build it into your budget.

Understanding freelance taxes 

Freelancing comes with plenty of benefits — more flexible hours, ability to control your schedule, and how much you charge — but one of the biggest challenges is managing your own taxes. When you’re an employee, your employer will typically calculate how much money needs to be withheld for taxes, and will pay that amount to the IRS and state department each year. 

If you earn any income doing freelancing or contract work (even if you’re not a full-time freelancer) you’ll have to set aside that money yourself to compensate for the taxes you will owe the government. 

If that wasn’t enough, you’ll also have to make quarterly payments to the IRS in the form of estimated tax payments. To avoid a nasty surprise come April 15, it’s important to accurately estimate and set aside how much money you should expect to pay in income tax. We suggest setting aside 25-30% of your freelance income into a separate savings account to cover the taxes — but this is just a rough estimate! Read on to fine-tune what you will likely owe and build it into your “breakeven number.” 

Estimating your taxes 

No need to go to an accountant to calculate this — there’s an efficient formula to figure out how much you may owe Uncle Sam. 

Expenses + Income requirements + Taxes = Your Breakeven Number 

You’ve already figured out your expenses and income requirements to factor into your salary goal. Next, figure out the type of taxes you may need to pay, which includes sales tax, income tax, and investment tax. 

Sales tax and fees 

You’ll pay sales tax and fees as a freelancer if you sell items or utilize online transactions as part of your business:

• Credit card fees 

• Service fees: any third-party fees, like sales commissions or platforms

• Other fees: this includes any other sales that have a transaction fee ‍

To calculate how much you’ll pay annually in sales fees, determine what percentage of your sales are from each type of provider and how much the transaction fee is for each. Take your estimated revenue in sales and multiply it by each sales fee. 

Here’s an example:

Let’s say you have your own jewelry–making business and are expecting to gross $50,000 in sales. 80% of your sales are from credit card transactions on your website (which come with a 3% transaction fee), and the other 20% are from a selling platform that charges a 10% service fee. 

To calculate how much you’ll pay in fees:

First, 80% of $50,000 is $40,000, or the amount from credit card transactions. Three percent of that number is $1,200 — that’s the estimated amount you’ll pay in credit card fees. 

Next, 20% of $50,000 is $10,000, or the amount from the third-party platform. Ten percent of that number is $1,000 — that’s the estimated amount you’ll pay in service charges to the platform. ‍

Add both of those numbers together to get $2,200 — that’s your total anticipated annual sales fees. ‍

Use your workbook to calculate your estimated annual sales fees. 

Income tax

These are the taxes every freelancer will have to pay. As we said before, the quick and easy way to calculate how much to factor in is simply multiplying your income goal by 25-30% (we also have a playbook on this if you want to go even deeper).

But, if you want a more exact figure, here’s how to figure it out:‍

1. What’s your tax filing status? This 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 as filing “single.” 

2. Next, add together your expenses, sales fees and income requirements to get your total income. Let’s go back to the example in the last step ($48,000 in expenses plus $6,000 in additional savings equals a $54,000 income goal). Add in your sales fees ($2,200) to get a total income of $56,200. 

3. Once you have your total income, 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 calculate your federal tax yourself by using the IRS’ tax rate brackets, or you can use an online calculator like this one. For this example, the federal income tax on a $56,200 income is $7,981. 

4. You’re not done yet — you need to factor in state income tax as well. 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 — the average is around 9.9%. Using the same example, let’s say you live in Massachusetts, which has a flat income tax of 5% — which means you’ll pay around $2,810 in state taxes. 

5. Add your expected federal income tax and state income tax together and for the purpose of our example, you can estimate paying around $10,791 in taxes. 

Putting it all together

Let’s go back to that original calculation to get your breakeven number:‍

Expenses + Income requirements + Taxes = Your Breakeven Number 

Using the example above, your breakeven number is:

$48,000 + $6,000 + $2,200 + $10,791 = $66,991 (this is your minimum target revenue) ‍

Remember, this is just an estimate. 

While it’s helpful to calculate your taxes ahead of time, you may be able to use deductions or tax credits to lower your overall tax bill. There are tax deductions exclusive to freelancing that you may be able to take — and you’ll definitely want to take advantage of all the tax deductions you’re eligible for. 

Next, let’s factor in your billable hours and how you plan to structure your new freelance schedule. 

Recap

• You learned why building a tax buffer for your income goals is important. 

• You used a formula to figure out potential sales tax and income tax.

• You calculated your break-even number.