How Much Money Should I Save For Taxes?
An concise guide to keep you covered come the dreaded season
Like that annoying song your uncle plays at every thanksgiving dinner, tax season is a cyclical thing, returning every year to toy with our anxiety. Tax season can be increasingly stressful if you’ve recently started a business, worked as a freelancer/contractor, or filed for unemployment. And despite googling how much money to save for taxes you’re still left with a sinking feeling that you’re going to be hit with a high price tag at the end of your filing statement. I’ve been there, girl, and I know the fear and anxiety you’re feeling right now.
That’s why I’m putting together this blog, so we can finally put the tax fears behind us and strut into April knowing that we’re on top of the game.
The General Rule
The general rule for taxes is to set aside 20-30% of your income. If you're an employee for a company or business, they should be doing this automatically for you, but you may want to fill out a new W4 withholding firm or check-in with your employer to make sure they’re withholding the correct amount you want. If you’re self-employed, you’ll have to be diligent and set aside taxes yourself! I’d suggest doing this on a semi-monthly or monthly basis, depending on your spending and saving styles. Oh, and make sure it’s in a high yield savings account so you can generate money from your savings.
You’re probably wondering how this can be so dang high! 30% is A LOT. Well, it comes down to this, you’re not only paying federal and state income tax, but you’re also paying self-employment taxes which include 15.3% for your share of Social Security and Medicare. When you’re employed with a company, half of this is typically taken out of your paycheck automatically while the other half is covered by your employer. But, as a self-employed superhero you’re required to pay the entire 15.3% yourself. The other 12-15% that you’re saving comes from your income tax.
However, if you’re over there raking in the dough like the queen that you are and make:
More than $40,000 and file as single
More than $80,000 and file joint
More than $53,000 and file as the head of the household
Then your income tax bracket might be 22% or higher, and you’ll need to adjust accordingly. You can look at the Tax Foundation’s income brackets to see what you should save.
Now, everyone has their own unique circumstances surrounding their tax statements, and there are different types of taxes depending on your field of work, so let’s break it down even farther.
Unemployment Taxes
We’ll start here because I know so many people who filed for unemployment in light of COVID-19 and the subsequential mass layoff across the nation. What a lot of people don’t know is that their unemployment income is taxable. Even the federally mandated $600 weekly bonus from the COVID relief fund. This is because unemployment money is considered income and therefore is taxed as such.
That means if you cashed in on any unemployment during COVID-19 or otherwise, you’re expected to pay a portion of it back come tax season. In some states you’ll only pay federal income taxes, but in others you’ll have to pay federal and state taxes on your unemployment. Here is a list of states that DO NOT tax unemployment benefits at the state level - but remember you’ll be taxed federally no matter what:
Alabama, Alaska, California, Florida, Montana, Nevada, New Hampshire, New Jersey, Pennsylvania, South Dakota, Tennessee, Texas, Virginia, Washington, and Wyoming.
Check out this article from Kiplinger for a comprehensive guide to your state’s unemployment taxes.
Some states, like California, will offer to withhold 10% of your unemployment for taxes for you, you just have to check the indicated box when you certify for each week. Other states don’t even give you the option. However, note that the withheld portion is only 10%, when, in fact, your federal tax bracket is most likely higher than 10%. Meaning, this withheld portion likely does not cover all of your federal taxes from unemployment. Smartasset has another great tax bracket for 2019 & 2020, check it out here to find out what percent of unemployment income you’ll actually owe.
Freelancers, Contractors, and Corporations
So you freelance as a blogger on the side, signing contracts as you go as opposed to starting your own business. Or, you have started your own business as an S or C corporation. You’ll have to pay Estimated Taxes quarterly as you earn income throughout the year. These estimated taxes apply to S corporations, freelancers, and contractors who expect to owe $1,000 or more on their taxes at the end of the year. C corporations have an even lower bar at just $500 in taxes. To pay these taxes, you’ll need to fill out a 1040-ES. Thankfully, the IRS includes how to properly estimate your taxes right there on the sheet.
If you don’t pay these estimated taxes, or pay too little each quarter, you’ll be hit with a penalty fine upon filing at the end of the season.
Note: If you’re an LLC you’re considered a pass-through entity and don’t have to worry about estimated taxes (unless of course you’ve opted to be taxed as an S corporation).
Taxes as an LLC
Limited Liability Companies, or LLCs are taxed differently than other small businesses. As noted before, they’re what we call a pass-through entity, where the taxes pass through the business and flow right into your personal tax filings as an individual. For an LLC, you pay at the end of the year when you file, and should follow the standard 25-30% savings suggestion.
If you are in a multi-member LLC, where you started a cool company with your bestie and share ownership, things are a little bit different. When you started up your LLC partnership you were asked to designate a percentage of ownership of the company. Many people split 50-50, but sometimes that’s not the best option. If you have an unequal split, say you own 60% of the company while your partner owns 40%, you’ll need to remember to set aside taxes based upon your share of the profits, not the profits altogether.
What does this mean? If your LLC makes $100,000 annually, the owner of 60% of the company will be taxed on $60,000 and the owner of 40% will be taxed on $40,000. So, the 60% gal should set aside 30% of her $60,000 share and the 40% gal sets aside 30% of her $40,000.
Tax season is not something to fear if you stand steady and prepare yourself properly. Always cover your bases and never stop doing the research, especially if your company undergoes big changes in profits!
Remember that the higher percentage you put away throughout the year not only means a lower risk of owing money you don’t have, but also a higher chance you’ll walk away with more money saved than you needed, which can easily become a nice nest egg investment as the years roll on.