Taxes When You Become Self-Employed

The transition from employee to self-employed is one of the most significant tax shifts many people experience. Where your previous employer handled withholding and paid half your Social Security and Medicare taxes, you're now responsible for all of it — and the learning curve can lead to painful surprises at tax time if you're not prepared.

The most jarring new cost is self-employment tax — 15.3% of your net self-employment earnings up to the Social Security wage base ($168,600 in 2024), then 2.9% on income above that. As an employee, you paid half (7.65%) and your employer paid half. Now you pay both halves. The one offset is that you can deduct 50% of the self-employment tax you pay as an above-the-line deduction on your personal return. On $100,000 of net self-employment income, you'd owe approximately $14,130 in self-employment tax — a figure that's separate from and on top of regular income tax.

Because there's no employer withholding taxes from your paychecks, you're expected to pay as you go through quarterly estimated tax payments. These are due April 15, June 15, September 15, and January 15. Missing or underestimating estimated payments triggers underpayment penalties (even if you ultimately pay everything owed when you file). A common approach is to set aside 25-30% of every client payment you receive in a separate account earmarked for taxes, then use that to make estimated payments — which prevents the temptation to spend money that's actually owed to the IRS.

The significant upside of self-employment is the range of business deductions available to reduce your taxable income. Legitimate business expenses — including the cost of a home office (if you qualify), business use of your vehicle, professional subscriptions and software, equipment, professional development, marketing, and business insurance — are all deductible on Schedule C. Health insurance premiums you pay for yourself and your family are 100% deductible as an above-the-line deduction (not on Schedule C, but on Form 1040), as long as you're not eligible for employer-sponsored coverage. Retirement plan contributions — to a SEP-IRA, SIMPLE IRA, or Solo 401(k) — are also deductible and can shelter a large portion of your self-employment income from both income and self-employment tax.

The qualified business income (QBI) deduction allows most self-employed individuals and single-member LLC owners to deduct an additional 20% of their qualified business income from taxable income — on top of all other deductions. For a self-employed person in the 22% bracket earning $80,000 of business income after expenses, the QBI deduction alone could save over $3,500 in federal income tax. This deduction is available through 2025 under current law. Keeping careful records, using accounting software, and working with a tax professional who understands self-employment are all investments that pay dividends in reduced taxes and avoided penalties.