How to Pay Self-Employment & Estimated Tax on Your Freelancing Profits
The IRS wants you to pay tax on your net profit as you earn it
A surprising number of freelancers incur losses, and some consider that a good thing. A business profit means more taxable income, and it increases both your regular income tax and your self-employment tax, whereas a loss can offset other income.
The Self-Employment Tax
The self-employment tax is calculated on Form 1040 Schedule SE, and it's a somewhat significant 15.3% of your net business profit. It represents the Social Security and Medicare taxes that you would otherwise share with your employer, each of you paying half on your behalf. So you'd only pay 7.65% as an employee because of your employer's equal contribution.
But you are your employer if you're a freelancer, so you have to pay both halves—thus the self-employment tax. There are a couple ways you can approach paying it.
You Can Pay the IRS Monthly...
Ideally, you'll send the IRS money toward your self-employment tax every month in the form of estimated tax payments.
Technically, these estimated payments are referred to as quarterly estimated payments because the IRS won't start throwing interest and penalties at you unless you skip paying in a given quarter or you pay too little for the tax liability that you'll ultimately end up owing. This doesn't mean you can't pay in monthly, however. If you do, you're basically paying just a month or two in advance.
Let's say you have a net profit from your freelancing side gig of $2,000 at the end of January. Your self-employment tax would be $306 for that month: $2,000 x 15.3%. You can send an estimated tax payment to the IRS right then and there so you won't have to worry about paying that plus two more months at the end of the quarter—or 11 more months' of profits at year's end, plus interest and penalties if you don't pay until then. The IRS imposes these penalties because it really wants taxpayers to pay as they go.
...Or Pay Quarterly
Paying monthly might not be too challenging if your business income is pretty steady, but that's not always the case with freelancers. If you send the IRS money at the end of January, then you end up having a pretty bad February and March, you might really wish you could have that $306 back to help make ends meet. Your whole quarterly payment might work out to be only $500, and you've already contributed more than half of that in the first month alone.
The good news here is that you're actually paying for the quarter behind you when you pay estimated taxes four times a year. Here's how it breaks down:
- Payment Period Jan. 1 through March 31: Due Date April 15
- Payment Period April 1 through May 31: Due Date June 15
- Payment Period June 1 through Aug. 31: Due Date Sept. 15
- Payment Period Sept. 1 through Dec. 31: Due Date Jan. 15 of the following year
What to do? Set aside that $306 each month—or whatever you end up owing at month's end based on your net profit—in a segregated bank account. Don't touch the money. Do this at the end of January, February, and March, then send the IRS a payment two weeks later on April 15.
You're still paying as you go, but the IRS gives you a little wiggle room of a month or two on the first month of the quarterly payment period.
An Important Caveat
Unfortunately, that $306 a month that you're sending in monthly or quarterly isn't your entire tax liability. It's just your self-employment tax—Social Security and Medicare. You also have to pay income tax on your freelancing income, and this is where estimating comes into play.
You won't know exactly what your income tax liability will be for the year until year's end...and your tax bracket depends on your annual, not monthly, income. Again, if your net profit is fairly consistent, this shouldn't be too much of a problem. This might be the case if you've been freelancing for a while, so you know what to expect financially. Otherwise, you'll have to make your best guess many months in advance of the close of the tax year.
Calculating Your Income Tax Rate
Let's say you're single and you're pretty sure you're going to have a net profit of $2,000 a month every month all year. This is your only source of income, so this puts your total income at $24,000. You realize this puts you in the 12% tax bracket as of 2019 because the 22% rate doesn't start for single filers until they reach incomes of $39,475.
So does this mean you have to set aside an additional $240 a month for income tax? Not quite. The U.S. tax system is progressive—you pay a higher percentage as you earn more, so you won't owe 12% on your entire $24,000 net profit for the year. As of 2019, the first $9,700 of your income is taxed at just 10%. You'll owe $970—10% of the first $9,700—plus $1,716, or 12% of the $14,300 difference between your $24,000 profit and that first $9,700, for a total of $2,686.
Divide this by 12 months, and you should send the IRS an additional $224 a month...per quarter.
What If Freelancing Is a Side Job?
Calculating your estimated income tax would work the same way if you hold down a regular job and freelance on the side. You don't have to worry about sending in estimated payments on the income from your regular job—your employer withholds from your pay and takes care of that.
Let's say you earn $40,000 from that job, plus that $24,000 from your side enterprise. The tax rate that applies to your side job would be the one that starts with your 40,001st dollar, up through your 64,000th dollar. If you're single, this puts all your freelance earnings in the 24% tax bracket as of 2019.
You should send the IRS an extra $5,760 a year: $24,000 times 24%. That works out to an additional $480 a month because adding your freelancing income to your regular income puts you in a higher progressive tax bracket.
Remember, This Is Your Net Income
You're not doing all these calculations on the total income your freelancing brings in. The IRS isn't that heartless. You get to deduct "ordinary and necessary" business expenses from what you earn. You only pay self-employment tax and income tax on the balance—your net, not gross, profit.
According to the IRS, an ordinary expense is one that's commonly incurred in your business. Necessary means that it's helpful and appropriate to earning that income.
You can calculate your net profit using Schedule C, Profit or Loss From Business, and submit it with your tax return.
If You Have a Loss
So what happens if you complete Schedule C and come up with a negative number? You have a business loss.
Business losses can offset other income and reduce your overall income tax. If there's no net income, there won't be any self-employment tax on your freelance business, either.
Electronic Federal Tax Payments
Self-employed freelancers can enroll in EFTPS, the Electronic Federal Tax Payment System, to make monthly or quarterly estimated payments. It takes a little time at first to get set up with EFTPS, but you can then make payments by phone or online and have the payment debited directly from your checking account.
Another option is IRS Direct Pay. You don't have to register to use Direct Pay, but you'll have to enter in your identifying information each and every time you sign on to make a payment.