So - you are a freelancer, or hired on a consulting contract. There are plenty of benefits. Usually you get to make your own schedule. You know exactly how much you will get paid. You get to pick and choose the jobs you take on - making sure they align with your skillsets or interests. However, there are a couple of complexities that come with it as well. The one I want to focus on today is Self-Employment Taxes.
All individuals in the United States owe Social Security (12.4%) and Medicare Taxes (2.9%). When you are a full time employee of a company, you cover half of those costs which is withheld from your paycheck, and your employer covers the other half on your behalf. When you freelance or consult, you are not an employee, you are self-employed. However, you still owe the Social Security and Medicare Taxes. So instead of just being responsible for half of the costs, you are now responsible for 100% of those costs.
There is a hidden benefit - since you are operating your own business, you can take certain deductions to reduce how much of the income you earned from freelancing gets taxed. But enough talk, lets walk through an example. First we we look at how the taxes would flush out if you were a full time employee, and then as a freelancer doing the same job.
For our example, lets say that you are a single filer, you make $100,000 a year, and you take the standard deduction.
Employee Calculation
Social Security and Medicare
As an employee - you are responsible for half of the costs of Social Security and Medicare taxes which are 6.2% and 1.45% respectfully. To make it easy, we can add those two together for a gross 7.65%.
$100,000 x 7.65% = $7,650
Your employer withholds this from your paycheck, and then adds their portion of the taxes (the other half which is $7,650), and remits it to the government on your behalf.
Income Taxes
Next, we must calculate your income taxes. Since you take the standard deduction, which in 2023 is $13,850, your taxable income is:
$100,000 - $13,850 = $86,150
Using the 2023 tax bracket tables (refer to our blog post on tax brackets for an explanation), the total income taxes due are $14,260.60.
Totals
In conclusion, on $100,000 of gross income total taxes paid were $21,910.60 which is 21.91% of gross income. Now lets compare this to the same fact pattern, but if you were a freelancer.
Freelancer
Social Security and Medicare (aka Self-Employment Tax)
As a freelancer, you are responsible for 100% of the Social Security (12.4%) and Medicare Taxes (2.9%), which is a total of 15.3%. However, you are also allowed to take some business deductions. For this example, lets say that you have incurred about $15,000 of expenses to operate your business. This includes equipment you purchase, advertising and marketing you perform, and other general and administrative expenses. This directly reduces your gross income.
$100,000 - $15,000 = $85,000
So your net income from your business is $85,000. Now you have to pay your self-employment tax at 15.3%. But (because the IRS likes to make it complicated), only 92.35% of your net income is subject to self-employment tax. So lets do that calculation.
Income subject to self-employment tax: $85,000 x 92.35% = $78,497.50
Self-employment tax: $78,497.50 x 15.3% = $12,010.12
Income Taxes
Time to calculate the income taxes. Even though we use $78,497.50 to calculate self-employment tax, we have to use the net income number for the basis for our income taxes. So we must take out our standard deduction.
$85,000 - $13,850 = $71,150
But as a freelancer, in addition to your standard deduction, you also get to deduct 50% of your self-employment tax from your taxable income. So in the end, your taxable income is:
$71,150 - ($12,010.12 x 50%) = $65,144.94
Using the same 2023 income tax bracket tables, this results in total income taxes due of $9,639.49
Totals
In conclusion, on the $100,000 of gross income earned you will pay a total of $21,649.61 which is 21.65% of gross income.
Conclusion
So, is freelancing really better? The truth is, it comes down to what you value more: flexibility and autonomy, or simplicity and stability.
As our example shows, freelancers may pay slightly less in taxes, but this comes with the responsibility of managing your own business records, keeping meticulous track of expenses, and making quarterly tax payments. On the flip side, being your own boss allows you to shape your work to fit your life and potentially save on taxes if you’re diligent with your finances.
If you’re up for the challenge and eager to take control of your career, freelancing can be a rewarding path. But if you prefer the structure of a steady paycheck without the extra administrative work, sticking with traditional employment might be the better option for you.
Thanks for reading, and feel free to reach out if you have any questions or need clarification. Whatever path you choose, make sure it’s the one that aligns best with your goals and lifestyle. Follow us for more helpful information on taxes, small business, personal finance and accounting!
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