How Do Consultants Pay Taxes?

Learn What Taxes Independent Consultants Must Pay

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Consultants are experts in a particular field who share knowledge and insights with paying clients or employers. Starting a consultancy is a way to start your own business and work on a contracting basis. However, while self-employment brings many freedoms and benefits, it also comes with more tax responsibilities. 

Learn more about the types of taxes you’ll pay as a consultant so you can plan in advance and avoid surprises come tax season.

Key Takeaways

  • Self-employed consultants run their own businesses that serve clients.
  • When self-employed, you’re responsible for income taxes ranging from 10% to 37% of your net profit and a self-employment tax of 15.3%.
  • If you expect to owe more than $1,000 in federal taxes, you’re required to pay estimated quarterly taxes.
  • You may also owe taxes to your city and state governments.

Consultants Are Usually Self-Employed

According to the IRS, you are self-employed if you’re a business owner or contractor who provides services to other businesses. To remain a contractor rather than an employee, you must:

  • Have the right to direct or control the work you perform.
  • Have the right to direct or control the financial and business aspects of your job.
  • Have a relationship that is not like one of an employer and employee (e.g., it must be impermanent, and benefits such as insurance or vacation pay are not generally granted). 

Some consultants are hired full-time by one company and have their taxes withheld just like any employee. However, many self-employed people who run their own businesses must manage their own taxes; for them, it’s critical to understand how self-employment taxes work.

How Self-Employment Taxes Work

If you are self-employed, your clients will pay the full amount you bill—with no taxes deducted. So if your service costs $1,500, you will be paid $1,500. However, that doesn’t mean you don’t owe taxes on your earnings.

Self-employed consultants typically need to pay both federal income taxes and federal self-employment taxes. The amount you owe for income tax will depend on your tax bracket. For 2021, tax rates range from 10% to 37%, with your rate depending on your amount of net profit.

Further, the self-employment tax rate is 15.3% of 92.35% of your net profit. It consists of 12.4% for Social Security and 2.9% for Medicare.

Self-Employment Tax Example

Here’s an example of how independent consultants' taxes work.

If your consultancy’s net profit is estimated to be $120,000 in 2021, and your filing status is single, you could potentially owe $39,776 in annual federal income tax. Here’s how the calculation works: 

First, according to the 2021 Tax Rate Schedules, you would owe $14,751 in income tax plus 24% on the amount over $86,375, which is $33,625.

$120,000 - $86,375 = $33,625 

That $33,625 is subject to the 24% tax rate, which equals $8,070.

 $33,625 x 0.24 (24%) = $8,070

So you would owe $14,751 plus $8,070 in income tax, totaling $22,821.

You also have to factor in self-employment tax by calculating 15.3% of $110,820 (92.35% of $120,000), which is $16,955. In summary, your total estimated taxes would be $39,776, which is approximately 33% of your net income.

$22,821 + $16,955 = $39,776

Once you know how much you will likely owe for the year, you have to split it into four equal payments, because they are due each quarter. Using the example above, the quarterly payments would be $9,944 each. Of course, this is a simplified example, and you may have deductions or other factors that could change the amount you would ultimately owe.

Consultant taxes summary:

  • Net profit earned: $120,000
  • Income tax: $22,821 ($14,751 plus 24% on amounts over $86,375)
  • Amount over $86,375: $33,625
  • 24% of $33,625: $8,070
  • Self-employment tax: $16,955
  • Total federal tax: $39,776
  • Estimated quarterly payments: $9,944
  • Federal tax % of income: 33%

Not sure where to start? You can work out your estimated taxes on the 1040-ES IRS form.

Then, when you’re ready to make your payments, you can do so by mail, online using the Electronic Federal Payment System (EFTPS), via debit or credit card, or through IRS Direct Pay.

In 2021, up to $142,800 is subject to the Social Security part of self-employment tax per taxpayer. However, all earnings are subject to the Medicare self-employment tax.

Tax Deductions for Consultants

Deductions enable you to reduce your taxable self-employment income, which means you’ll owe less in taxes. For example, if you made $120,000 but spent $40,000 on deductible expenses, your taxable income would only be $80,000, which would drop you into a lower tax bracket.

As a consultant, you may be wondering what deductions are available to you. Here’s a quick list of some common deductions:

  • Self-employment tax deduction: You can deduct half of your self-employment tax each year, equivalent to what an employer’s portion would be, but it will only affect your income tax.
  • Capital investments: Purchases you make to get your consulting business up and running, such as computers or furniture, can be capitalized, and their depreciation can be deducted over time.
  • Operating expenses: These are expenses you must pay to run your business, such as rent, internet service, phone bills, utility bills, or software programs.
  • Career development: You can qualify for education tax credits if you’re attending a qualifying college program, and can write off the costs of webinars, seminars, conferences, and professional certifications.
  • Advertising and costs for client services: You can deduct any costs spent on advertising of client acquisition, such as setting up a website, getting professional headshots done, travel expenses, dining and entertainment expenses, and gifts used for business.
  • Business use of your home or car: If you have a home office, you can write off a portion of your housing costs for that space, including rent, mortgage interest, insurance, utilities, depreciation, and repairs. Likewise, if you use your car for business, in whole or in part, you can write off expenses such as depreciation, lease payments, gas and oil, tires, etc.
  • Financial fees: You can write off any fees you have to pay your bank or credit card companies.
  • Other: Other deductible expenses include retirement savings plans and business insurance.

While keeping track of all of your expenses throughout the year can seem daunting, it’s well worth it. Be sure you’re getting all of the deductions you qualify for so you won’t pay more in taxes than you should.

How to File Your Taxes

Each year, most tax returns need to be submitted by the IRS deadline, which is usually April 15. As a self-employed consultant, you’ll need to file Form 1040 or 1040-SR, and you will need to attach Schedule C to figure your business’s net profit or loss.

Be sure to consult a tax attorney about any additional forms that may apply to you. Estimating your quarterly taxes on time (and estimating them correctly) can help you avoid any surprises.

Estimated quarterly self-employment taxes are usually due on the following dates:

  • Payment 1: April 15
  • Payment 2: June 15
  • Payment 3: September 15
  • Payment 4: January 15

As long as your payment is postmarked by the due date, it’ll be considered on time. If you pay late or don’t pay the required amount, you could face penalties. If you underpay by more than 10%, you can also be penalized.

Don’t Forget State and Local Taxes

In addition to federal taxes, don’t forget about the state and local taxes that apply to you. Be sure to look up your state and local tax boards to see what you will have to pay, and whether quarterly payments are mandatory. For example, California requires you to pay estimated tax payments if you will owe $500 or more in 2021.

Becoming self-employed and starting a consulting business can be very exciting and profitable. Don’t let a large, intimidating tax bill discourage you. Avoid surprises by understanding your tax liabilities and staying on top of your quarterly estimated payment responsibilities.

Frequently Asked Questions (FAQs)

Which employer taxes will you pay as a consultant?

As an independent consultant, you will need to pay 100% of your Social Security and Medicare taxes. Employees generally split these with their employers and have their portion withheld from their paychecks. However, when you’re self-employed, you must pay for them in full. That said, you can deduct half of your self-employment taxes from your income tax liability.

What percentage of your income should you pay for quarterly estimated taxes?

If you expect to owe more than $1,000 when your tax return is filed, you’ll need to pay quarterly estimated taxes. If you don’t, or if you don’t pay enough, you will face a penalty. The percentage of your total income you have to pay will vary based on your earnings and tax status. To figure it out, you’ll need to complete IRS form 1040-ES. It has a worksheet where you’ll enter your expected income and profits, deductions, credits, and more to figure out how much you should be paying each quarter.