Note: this guide is an explaination of the methodology used in the Freelance Project Tax Calculator, which you can download here.
The best time to to understand your tax liabilities when freelancing is before you take on a project--not at the last minute before taxes are due.
By understanding how freelance taxes work, you can price yourself based on what you want your take-home pay to be.
The goal of this guide is to help you understand the basics of your tax liabilities as a freelancer, and give you a way to calculate your tax withholding and take-home pay.
This method calculates your annual tax liabilities and divides them by your estimated annual self-employment income, giving you a tax withholding rate that you can use throughout the year to set aside money as you earn it. This way, when it comes time to pay your taxes, you’ll be prepared to pay them without an unpleasant surprise.
In this guide, we’ll explain how to:
- Calculate your self-employment taxes and withholding rate
- Calculate your state and local income tax liability and withholding rate
- Calculate your federal income tax liability and withholding rate
- Using your total tax withholding rate to determine what to set aside
Throughout this guide, we’ll walk through this with a part-time freelancer named Susan, who:
- lives in New York City
- files taxes as a Single with one dependent
- makes $30K/year as a part-time w2 employee
- makes $30K/year freelancing
Step One Calculating your self-employment taxes and withholding rate
If you have over $400 in freelance income, then you need to pay self-employment taxes.
Only 92.35% of your freelance business' net profit (AKA self-employment income) as a freelancer is taxable for self-employment tax.
Self-employment taxes include Social Security and Medicare taxes. Medicare taxes are 2.9% of your taxable earnings, and Social Security taxes are 12.4% (but only on the first $127,200 of your income).
Self-employment taxes for those making under $127,200 annually
If you’re making less than $127,200 in self-employment income annually (like Susan), it’s pretty simple:
- Multiply your Annual Self-employment income ($30,000) by 92.35% to determine the taxable amount ($27,705).
- Calculate your annual self-employment taxes by multiplying the taxable amount by 15.3%: 2.9% for Medicare and 12.4% for Social Security ($27,705 x 15.3% = $4,239).
- Divide by your annual self-employment income to get your self-employment tax withholding rate ($4,239 / $30,000 = 14.13%)
This means that for any self-employment income you make, 14.13% of it should be set aside for self-employment taxes. While we used $30,000 as an example, 14.13% is the withholding rate for everyone under the $127,200 threshold.
Self-employment taxes for those making over $127,200 annually
If you make over $127,200, your withholding rate will be lower and you need to calculate Social Security taxes and Medicare Taxes separately. Using $150,000 as annual self-employment income:
- Medicare: Multiply your Annual Self-employment income ($150,000) by 92.35% to determine the taxable amount ($138,525), and calculate medicare taxes by multiplying taxable amount by 2.9% ($138,525 x 2.9% = $4,018).
- Social Security: Since only the first $127,200 of income is taxable for social security, multiply $127,000 by 92.35% to get the taxable amount ($117,470), and then multiply that amount by 12.4% ($117,470 x 12.4% = $14,567).
- Add your medicare taxes and social security taxes to get your total self-employment taxes ($4,018 + $14,567 = $18,585). Divide that by your annual self-employment income to get your self-employment tax withholding rate ($18,585 / $150,000 = 12.39%).
If you’re above the $127,200 threshold, your withholding rate goes down the more you make. For example, while someone making $150,000 annually has a self-employment tax withholding rate of 12.39%, someone making $250,000 annually has a self-employment tax withholding rate of 8.5%.
While self-employment taxes are a large burden on freelancers that traditional w2 employees don’t have to deal with, half of your self-employment taxes can be used as a federal deduction on your income taxes. We’ll outline how to deal with that below.
Step Two Calculating your federal income tax liability and withholding rate
Calculating your federal income tax liability and withholding rate is a bit more complicated, but it can be summarized by 5 steps:
- Determine your annual gross income (including any W2 income)
- Determine your adjustable gross income after the “One-half of self-employment tax” deduction
- Calculate the Federal Taxable income after standard deductions and personal exemptions
- Use federal income tax brackets to determine your Annual Federal Income tax Liability
- Divide your tax liability by your annual gross income to determine the percentage of freelance income you should be setting aside for federal taxes.
We’ll illustrate this with Susan.
Determine your annual gross income (including any W2 income)
Susan makes $30,000 from her W2 income, and $30,000 from freelancing, so her annual gross income is $60,000. As we’ll see later, having W2 income means that you’ll need to withhold a larger portion of your freelance income for income taxes compared to full-time freelancers.
Determine your adjustable gross income after the “One-half of self-employment tax” deduction
Her annual self-employment tax is $4,239, so we’ll deduct half of that from her gross income (the “one-half of self-employment tax” deduction) to get her adjustible gross income ($60,000 - $4,239/2 = $57,881). Note: there are other deductions that can lower your adjustible gross income. These are called “above-the-line” deductions, and you can see others here.
Calculate the Federal Taxable income after standard deductions and personal exemptions
Aside from above-the-line deductions, you can claim a standard deduction (a flat-dollar, no-questions-asked reduction in your adjusted gross income) or choose to itemize your deductions. If you think you have deductions that may exceed your standard deduction and are willing to spend time and money on it, you should itemize your deductions.
However, a majority of Americans (and an overwhelming majority of freelancers) go the standard deduction route, so that’s what we’ll use in this method.
Your standard deduction is based on your filing status. Here are the standard deductions for 2017:
Continuing with our example, Susan is filing as a Single, so she gets the standard deduction of $6,350.
Now it’s time for personal exemptions, which are standard amounts you can deduct for every taxpayer and dependent claimed.
If Susan were to have zero dependents, she would have one personal exemption (as the taxpayer). By claiming one dependent, she gets two personal exemptions. The exemption amount is a standard $4,050 in 2017, so Susan can deduct $8,100 in personal exemptions.
Then, we take Susan’s Adjustable Gross income ($57,881) and deduct her standard deduction ($6,350) and personal exemptions ($8,100) to get her federal taxable income ($43,431).
Use federal income tax brackets to determine your Annual Federal Income tax Liability
Once you have your federal taxable income, you use federal income tax brackets and your filing status to calculate your federal income tax.
There are seven federal income tax brackets, and depending on what your taxable income is, you'll pay a rate between 10% and 39.6%.
Married Filing Jointly / Qualified Widow(er)
Married Filing Separately
Head of Household
Continuing with our example, Susan’s taxable federal income is $43,431, resulting in $6,587 in federal income taxes.
Divide your tax liability by your annual gross income to determine the percentage of freelance income you should be setting aside for federal taxes.
When we divide Susan’s federal income tax by her annual gross income, we get her federal income tax withholding rate ($6,587 / $60,000 = 10.98%), which means that 10.98% of her self-employment income should be set aside for federal income taxes.
It’s important to note that part-time freelancers have higher income tax withholding rates than full-time freelancers because their self-employment taxes have a higher marginal tax rate.
Step Three Calculate your state and local income tax liability and withholding rate
Calculating state and local income taxes work similarly to federal income taxes, except there are some subtle differences and each state and locality may have different ways of calculating income tax. They have their own methods of calculating taxes, and have their own standard deductions, personal exemptions, and tax brackets.
In some places, you need to pay local income tax in addition to state income taxes. Local income taxes vary depending on where you live. There are only 14 states with areas that have local income taxes: including Alabama, Arkansas, Colorado, Delaware, Missouri, Indiana, Kentucky, Maryland, Michigan, New York, Oregon, Pennsylvania, Ohio, and Iowa.
If Susan lives in New York City, then her State income taxes are $2,952 (a 9.84% withholding rate) and her local New York City income taxes are $1,025 (a 3.42% withholding rate).
Here are how state and local taxes work in all 50 states (plus Washington D.C.), along with what Susan’s state income tax and withholding rate would be in each of them.
Step Four Use your total tax withholding rate to determine what to set aside
With all of your withholding rates for self-employment taxes, federal income taxes, and state/local income taxes, the hard part is over.
Take the sum of your tax withholding rates to get your final withholding rate. Here are Susan’s withholding rates:
- Self-employment tax withholding rate: 14.13%
- Federal income tax withholding rate: 10.98%
- State income tax withholding rate: 9.84%
- Local income tax withholding rate: 3.42%
- Total tax withholding rate: 38.36%
That means that for any money Susan makes freelancing, 38.36% needs to be set aside for taxes, and she can take home the rest.
Understanding what you can take home and what you should set aside for taxes allows you to set pricing accurately, and always be prepared for your quarterly taxes.
Want to do these calculations? Subscribe to our newsletter and get our Freelance Project Tax Calculator (a spreadsheet you can use to understand what you need to set aside for taxes)