Self-Employed Consultants and Taxes

According to the IRS, you’re 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 performHave the right to direct or control the financial and business aspects of your jobHave a relationship that is not like one between an employer and employee—it must be impermanent and benefits such as insurance or vacation pay are not generally granted 

If you’re a self-employed consultant, then your clients will pay the full amount you bill them with no taxes taken out. For example, you’ll be paid $1,500 if your service costs $1,500, but this doesn’t mean that you don’t owe taxes on that amount of earnings. Self-employed consultants typically have to pay both federal income taxes and federal self-employment taxes. The amount you owe for income tax will depend on your tax bracket. Tax rates range from 10% to 37%. Your highest rate depends on your amount of net profit. The self-employment tax rate is 15.3%—12.4% for Social Security and 2.9% for Medicare. You generally pay self-employment taxes on 92.35% of your net earnings.

How Taxes Work for Consultants

Here’s a simple example (with no tax deductions or credits) of how independent consultants’ taxes work. Let’s say you’re a single taxpayer and your net profit for your consultant business is $120,000 for the tax year. That places you in the 24% tax bracket. Here’s how you could figure out how much tax you’d have to pay on the $120,000 of net profit. We’ll use tax year 2022 (the return you file in 2023) for this example: First, you’ll want to find out how much income tax you owe. Because $120,000 falls into the 24% tax bracket, you’d pay 24% on the amount over the threshold for that bracket: $120,000 - $89,075 = $30,925 x 24% = $7,422 Next, you need to figure out how much tax you’ll pay on the rest of your net profits below that 24% tax bracket threshold. You’d pay:

10% on the first $10,275 (which equals $1,027.50)12% on the next $31,500 (which equals $3,780)22% on the next $47,300 (which equals $10,406)

This is all based on the tax brackets for the tax year. In total, after calculating all of the taxes above, you’d owe $22,635.50. After that, you have to figure out how much you’ll pay in self-employment taxes. You can do this by calculating 15.3% of 92.35% of your net profits: 92.35% of $120,000 = $110,820 x 15.3% = $16,955.46 Add $16,955.46 to the income tax of $22,635.50, and you get $39,590.96. That’s about 33% of your net income. It’s smart to make estimated quarterly tax payments to cover this tax bill if you can. For example, if you know in March that you’ll earn $120,000 for that tax year, you could calculate your tax bill and then split it up into four equal payments, sending a check to the IRS by April 15, June 15, Sept. 15, and Jan. 15. So if you know that you’ll owe $39,590.96, that would come to four payments of $9,897.74.

Summary

Net profit earned: $120,000Income tax bill: $22,635.50Self-employment tax bill: $16,955.46Total federal tax owed: $39,590.96Percent of net income: 33%Amount of each estimated quarterly payment: $9,897.74

You can work out your estimated taxes on the 1040-ES IRS form if you need help. 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.

Tax Deductions for Consultants

Deductions enable you to reduce your taxable self-employment income, which means you’d owe less in taxes. Your taxable income might be only $80,000. This would drop you into a lower tax bracket if you earned $120,000 but spent $40,000 on deductible expenses. Here’s a quick list of some common deductions that may be available to consultants:

Self-employment tax deduction: You can deduct half of your self-employment tax each year, equivalent to what an employer’s portion would be.Capital investments: These include purchases you make to get your consulting business up and running, such as computers or furniture, which can be capitalized. 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. You 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 expenses, and gifts used for business.Business use of your home or car: You can write off a portion of your housing costs if you have a home office, including rent, mortgage interest, insurance, utilities, depreciation, and repairs. You can write off expenses such as depreciation, lease payments, gas, oil, and tires if you use your car for business purposes in whole or in part.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.

How To File Taxes as a Consultant

Most tax returns need to be submitted to the IRS by the deadline each year. This is usually April 15, but it can shift by a day or two to accommodate weekends and holidays. You must file Form 1040 or Form 1040-SR as a self-employed consultant. You must attach Schedule C on which you’ve figured out your net profit or loss after accounting for deductible business expenses. Be sure to consult a tax attorney about any additional forms that may apply to you. Estimating your quarterly taxes on time (and correctly) can help you avoid any surprises. Estimated quarterly self-employment taxes are usually due on or around the following dates:

Payment 1: April 15Payment 2: June 15Payment 3: Sept. 15Payment 4: Jan. 15

Paying State and Local Taxes as a Consultant

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