How Much Should I Set Aside For Taxes: 1099 Self-Employed Edition

8 Min Read

Scope of Work

Taxes

Contractor

Maria Malyk

Maria is a freelance copywriter and language translator, with a PhD in sociology of culture and cognition and a background in academic, legal and financial writing. A digital nomad, Maria also keeps a travel blog while working on a guidebook for solo travelers on a budget.

If you are a freelancer / independent contractor wondering "How much should I set aside for taxes?" (1099-NEC / 1099 MISC tax forms), read on to see what you need to do to figure out what you owe in taxes -- as well as how to optimize this process so that it doesn't take up too much of your valuable time, effort, and nerves.

While the W-2 employees get to wait for their refund from the IRS after they file taxes in April, 1099 independent contractors are required to pay taxes -- and not just at the end of the year, but four times per year, once for each "quarter".

This is because W-2 employees have tax estimates withdrawn automatically throughout the year from their paycheck with their employer, whereas self-employed workers deal with multiple employers and clients, many of whom pay for their goods/services in full, pre-taxed. It is, thus, up to the independent contractor to calculate and pay the taxes they owe from the untaxed earnings to the IRS.

A general rule of thumb is to set aside 30-35% of your income for your taxes. In this article, we'll talk about all the taxes you'll need to pay and why you should save this percentage amount from the money you make.

Note: Those who think this sounds intimidating and labor-intensive can greatly improve the whole experience by signing up for Bonsai Tax. Our expense tracking app will help track money coming in and out of your business, sort deductions, file taxes, and estimate the quarterly taxes every ninety days, based on the income. Claim a 14 day free trial here.

Which Taxes Are 1099 Freelancers Responsible For?

1099 workers are expected to pay income tax on both federal and state level, as well as self-employment tax. Let's break down each of these.

Income Tax

This is an annual tax levied by the government on personal income.

Residents of all fifty U.S. states are subject to federal income tax, with a new tax bracket breakdown set by the IRS each year.

Most but not all U.S. states tax income. In 2021, eight American states have no income tax, ten have flat income tax, and the rest have graduated income tax.

Self-Employment Tax

1099 workers additionally pay self-employment tax (SE) to the IRS. The self-employment tax serves as a Social Security and Medicare tax for individuals working for themselves.

You need to pay SE taxes on 92.35% of your net earnings from being self-employed.

The SE tax rate for 2021 is set at 15.3% (12.4% for Social Security + 2.9% for Medicaid).

To quickly see how much money you'll owe, use our free 1099 tax calculator to figure out your total.

When Do Freelancers Pay Their Taxes?

Unlike W-2 workers whose taxes are automatically withheld with every paycheck, 1099 workers must set aside quarterly taxes to be paid to the IRS throughout the year.

Are Quarterly Estimated Tax Payments Mandatory?

Yes, paying quarterly taxes is obligatory for self-employed workers who will owe $1000 or more in taxes for the year.

The Pay-As-You-Go System

U.S. taxes are "pay-as-you-go": your estimated taxes are either withheld from every paycheck you receive from an employer -- or, if you are self-employed, you are responsible for withholding those sums yourself and paying them in full each quarter.

If the independent taxpayer fails to set aside and pay estimated quarterly tax in its entirety or misses the deadline, they may get fined, typically 3% of the tax owed (though, if they use the Bonsai Tax quarterly estimated tax payments calculator, they will be spared both, the fine and the stress...)

Quarterly Tax Due Dates For 2021 Tax Year

January 1 to March 31 -- April 15, 2021
April 1 to May 31 -- June 15, 2021
June 1 to August 31 -- September 15, 2021
September 1 to December 31 -- January 18, 2022 (however, if you file your 2021 taxes by January 31, 2022, and pay the entire balance due with your tax return, you don't need to pay this fourth installment).

You can pay estimated taxes through the IRS' app, online portal, or by filling out Form 1040-ES and mailing to the IRS, postmarked before or on the due date. If the deadline falls on a weekend or legal holiday, the estimated taxes payment is due the following business day.

Calculating The Estimated Quarterly Tax Payments For The Current Year

Your estimated quarterly taxes are supposed to be set aside and paid in four installments, equal ones if you can help it (if your income varies significantly from one quarter to the next, you will likely have to attach IRS form 2210 with your annual return). More frequent installments can be made, as long as they are equally distributed among the four quarters (e.g. 12 annual payments, once a month/three times per quarter).

Projecting An Income Estimate For The Tax Year

Independent contractors with steady incomes can estimate their current year's projected income on the basis of last year's earnings.

Those freelancers whose incomes fluctuate significantly from one quarter to the next may be better off calculating each quarter's individual tax payment on the basis of that quarter's income and expense deductions.

Identifying Your Marginal Tax Bracket

Once you have an idea of how much 1099 income you will make over the year, you can look up the tax bracket you belong to, which will determine the percentage of your income you need to save/put aside for estimated taxes each quarter.

Each year's federal income tax rate is different from the previous year's percentage. For example, for unmarried taxpayers in 2021, it goes as follows:

$0 - 9,950 -- 10%
$9,951 - 40,525 -- 12%
$40,526 - 86,375 -- 22%
$86,376 - 164,925 -- 24%
$164,926 - 209,425 -- 32%
$209,426 - 523,600 -- 35%
$523,601+ -- 37%

Keep in mind that the tax system is progressive, meaning that your income is not taxed at a single tax rate in its entirety, but at different rates for its different gradations. However much income you earn, it will be taxed as follows in 2021:

the first $9,950 is taxed at 10%
the next $30,574 is taxed at 12%
the next $45,849 is taxed at 22%
the next $78,549 is taxed at 32%
the next $314,174 is taxed at 35%
any income past that is taxed at 37%

Doing The Math For The Quarterly Tax Payments

Determining the estimated tax payments to set aside for taxes each quarter takes the following three steps:

Calculate Total Taxable Income. Take the projected income estimate you figured out earlier and subtract expected tax deductions you plan to claim for qualifying business expenses: this leaves you with your Adjusted Gross Income (AGI). Multiply the AGI by the tax rate attached to the income tax bracket that applies to your earnings: the resulting number is your income tax.
Calculate The Self-Employment Tax. Take your total income (before tax deductions) and multiply it by 92.35% to solve for your taxable income for the SE tax. Take this result and multiply it by 15.3% to get what you owe in self-employment taxes.
Calculate The Total Quarterly Payment To Set Aside For Taxes. Now, it's time to put it all together and break it up into quarterly payments. Add up the income tax and the SE tax: this is your total estimated taxes. Divide that number by 4: you now have your quarterly tax payment.

It Is Better To Overestimate Than To Underestimate A Quarterly Tax Payment

It is always advisable to err on the side of paying more when you pay your taxes. Whatever you overpay will be refunded to you eventually, whereas paying less will bring on tax underpayment penalties (and you will still need to pay the remainder of what you owe...)

With Bonsai Tax, You Will Always Know How Much Money To Set Aside For Taxes (And More!)

No business -- be it a large corporation or a one-person operation -- benefits from attracting the negative attention of the IRS.

Healthy Tax Record-keeping Is Essential

Running a "tight ship" on one's taxes may seem like a very daunting task for the already overextended 1099 worker. First of all, it does not have to be -- and second of all, noncompliance with the tax system will result in other daunting and costly consequences.

Mis-reporting income and tax deductions can lead to an IRS audit. Not paying on schedule incurs fines. Messy tax record-keeping leads to errors and misestimations on quarterly and end-of-the-year tax filing which, in turn, result in larger-than-expected sums of money owed to the IRS .

It is, therefore, imperative for every self-employed freelancer / independent contractor to either:

become very well-versed in taxes and become one's own fastidious accountant,
hire a professional accountant, or
utilize the help of a simple-to-use digital tax-tracking/sorting/calculating/filing tool

The last option will put you in charge of your taxes at all times while taking the majority of the accounting burden off your shoulders, allowing you to focus on your primary work and clients. Our expense tracker will help you avoid paying 1099 taxes. For a 1099 worker, that tool is Bonsai Tax (as well as its freelancer-oriented all-in-one workflow product suite).

Bonsai Tax Calculates Your Quarterly Income Tax And Self-Employment Tax (And Then Some)

The Bonsai Tax app is the happy medium between going it alone and hiring an accountant. The former is time- and effort-consuming, the latter is expensive. Adapting a digital, cloud-based tax tool, designed specifically for the 1099 contractors' needs, into your business-operating toolkit will do away with most of the labor, while not costing an arm and a leg.

The Bonsai Tax system records your income, scans and imports expense receipts, sorting them into deduction categories to write off at the end of the tax year, generates expense reports to keep you aware of your spending, provides quarterly estimates of how much money you owe in taxes, and fills out the majority of your tax return, come April tax time -- all the while safely storing your data in a cloud-based online account.

The Bonsai Tax software not only helps with tasks, it guides you through the tax record-keeping and filing chores, making you more mindful of doing taxes, while getting more comfortable with the process. Try it for free and experience the Bonsai peace of mind for yourself!

What Defines a Verbal Contract?

A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.

Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.

Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.

The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.

Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.

When is a Verbal Agreement Legally Binding?

For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:

Offer and acceptance: An offer is made and accepted by another party involved in the agreement;
Consideration: The involved parties must exchange something of value (money, a service, time, etc), this is known as consideration;
Intention and certainty: All parties must fully understand the terms of the contract and intend to make a legally binding agreement freely; and
Capacity: The parties must have the capacity to legally enter into the contract; they're above age and of a stable mindset.

Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.

How strong is a verbal agreement in court?

Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.

If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.

That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.

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When are verbal agreements not enforceable?

There are some types of contracts which must be in writing.

The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:

The sale of real estate or vehicles
Real estate leases lasting longer than one year.
Property transfer following the death of the owner.
The case of a party agreeing to pay debt for someone else.
Any contract that requires more than a year to fulfil.
A contract involving and exceeding a specified amount of money (which varies by state).

Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.

Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.

How are Verbal Contracts Enforced?

Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?

How can you prove an oral contract?

Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!

If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.

Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.

Written vs Verbal Contracts: What's the Verdict?

Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.

So, ultimately, the question is: written or verbal agreements?

Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.

Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.

"@bonsaiinc is probably my all time favorite freelance tool. hands down. the team is super responsive and accessible when i have questions."

David Urbinati

Motion design / animation

Say hello to digital contracts

Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.

There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.

Benefits of written contracts

A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.

Create Professional Contracts with Bonsai

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With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.

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