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ResourcesAccounting and Taxes

How To Calculate Taxable Income When You’re Self-Employed

Accounting and TaxesFebruary 14, 2024

Ever wondered how your tax preparer or tax filing software arrives at your final tax bill? The behind-the-scenes math of tax returns can seem tricky, but understanding how to calculate taxable income can help you save the most money on taxes. 

In this article, we’ll walk through how to calculate taxable income, so you can use that number to estimate how much you’ll owe based on your tax situation.

Step 1: Calculate your total income

Calculating your tax starts with understanding your Adjusted Gross Income (AGI). AGI plays a key role in tax calculations because it influences your eligibility for various tax breaks and credits. It's essentially your total income minus certain specific deductions.

For the self-employed, this means beginning with your business profit, which is your business income after subtracting expenses. For example, if your landscaping business earns $20,000 and incurs $5,000 in expenses, your profit is $15,000.

But it's not just about business income. You must also include other income sources such as:

  • Wages, tips, or salary (like W-2 wages from an employer)

  • Rental income

  • Unemployment benefits

  • Social Security benefits

  • IRA distributions

  • Other types of taxable income

For example, let’s assume you earned $25,000 in wages from a part-time W-2 job at a grocery store on top of your landscaping work. Your total reported income would be $40,000 ($15,000 in business income + $25,000 in wages).

Step 2: Deduct adjustments from your income

Adjustments are specific expenses that the IRS generally allows you to subtract from your total income, effectively lowering your AGI and, consequently, your tax liability. 

Some common adjustments include:

For example, let’s say you paid $1,000 in student loan interest and $1,000 in HSA contributions. You could subtract that $2,000 from your $40,000 in income, which would give you an AGI of $38,000 for tax purposes.

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Step 3: Calculate your adjusted gross income (AGI)

Once you’ve subtracted the applicable adjustments from your total income, you arrive at your Adjusted Gross Income (AGI).

AGI is a crucial figure in the tax calculation process as it not only affects your tax liability but also determines your eligibility for various tax credits and deductions. For example, if you file as “single” for 2023 and have one dependent, you may qualify for the Earned Income Tax Credit if your AGI is less than $46,560. 

For self-employed filers, AGI serves as a transition point in the tax calculation process. The deductions made to reach your AGI are termed 'above-the-line' deductions. After this, you'll encounter 'below-the-line' deductions, which we'll explore in the next section.

In our ongoing example, your AGI, after subtracting adjustments, stands at $38,000. This figure will now be used to further refine your taxable income.

Step 4: Subtract your deductions to find your taxable income

After calculating your AGI, the next question you may be asking is: How do I calculate my taxable income? You’re almost there! The next step is to subtract your 'below-the-line' deductions from your AGI.

For self-employed individuals, two key deductions to consider are:

  1. Qualified Business Income Deduction (QBI): This allows you to deduct up to 20% of your qualified business income, which is particularly beneficial for small business owners and freelancers. For example, if your business profit is $15,000, your QBI deduction could be $3,000 ($15,000 x 20%).

  2. Standard Deduction: This is a flat-rate deduction determined by your filing status. For the 2023 tax year, the standard deduction is $27,700 for married couples filing jointly and $13,850 for single filers and married couples filing separate returns. The standard deduction makes filing your taxes easier because you don’t have to itemize each deduction line by line. You just take the lump sum and call it a day. 

Continuing with our example: If your AGI is $38,000, subtracting the QBI deduction ($3,000) and the standard deduction for single people ($13,850) results in a taxable income of $21,150.

In certain scenarios, taking the itemized deduction might make more sense than taking the standard deduction. Itemizing lets you deduct an approved list of below-the-line deductions, such as medical expenses, charitable donations, and the SALT deduction for sales taxes and property taxes. If the total of your itemized deductions is greater than the standard deduction, itemizing is your best option because it will help you get your max refund. 

Step 5: Determine your federal tax liability and potential refund

The final step in determining your tax responsibility involves a few more calculations:

  1. Apply federal income tax rates. Use your taxable income number to find your federal income tax using the IRS income tax tables. These rates are progressive in the United States, meaning they increase as income rises.

  2. Add any additional taxes. For self-employed individuals, this includes self-employment tax, which covers Social Security and Medicare taxes.

  3. Subtract tax credits. Deduct any qualifying tax credits from your tax liability. Credits like the Earned Income Tax Credit or Child Tax Credit can significantly reduce your tax bill. 

  4. Consider pre-paid taxes: Deduct any taxes already paid throughout the year, such as estimated quarterly taxes or withholdings from other paychecks.

The number you’re left with is either:

  • A tax refund, if you’ve paid too much in taxes throughout the year, or if you’ve qualified for a refundable tax credit, or

  • A tax bill you need to pay before the April 15th deadline 

For example, let’s say you’ve run your taxable income amount of $21,150 through the federal income tax tables and found that you owe $3,000 in income and self-employment taxes, but you qualified for a tax credit of $1,000. Your tax bill would be:

$3,000 (owed tax) - $1,000 (credit) = $2,000

Big refunds or tax bills mean your withholding is off throughout the year. Aim for small refunds or small amounts owed—this signals your withholding matches liability. Adjust your tax withholding or estimated payments regularly to minimize the amount you owe or get refunded each year.

Frequently asked questions about calculating your tax bill

Is your gross income your taxable income? 

No, your gross income is not the same as your taxable income. Gross income is the total income you earn, including all wages, dividends, and other earnings before any deductions or adjustments. Taxable income, on the other hand, is the amount of income that is subject to tax after subtracting deductions and exemptions.

What counts as taxable income?

Common examples of taxable income include wages, salaries, bonuses, and tips, as well as investment income like interest income, dividends, and capital gains. It also encompasses other forms of income such as rental income, alimony received, business income, and certain types of Social Security benefits. But some income like certain gifts, inheritances, and life insurance payouts are generally considered nontaxable income.

Are tax brackets based on gross income?

No, tax brackets are based on your taxable income, not your gross income. Taxable income is the amount left after you have deducted all eligible expenses, adjustments, and either your standard deduction or itemized deductions from your total gross income. Tax brackets apply to this net figure to determine your tax rate.

How do I calculate how much tax I owe self-employed?

To calculate estimated tax payments for 2023 as an independent contractor, estimate your total annual income and deductions to find your taxable income. Then, calculate the income tax and self-employment tax you owe based on these figures. Divide this total by four to get your quarterly estimated tax payment. 

How is total self-employment tax calculated?

Your total self-employment tax is typically 15.3% of your net self-employment income. This consists of 12.4% for Social Security on income up to a certain limit and 2.9% for Medicare, with no upper limit. When you calculate your AGI, you can deduct half of this self-employment tax, effectively reducing your tax liability. Tools like Found can assist in these calculations by auto-generating necessary tax forms like Schedule SE, which is used for reporting self-employment tax.

How to calculate estimated tax payments for 2023 self-employed?

First, determine your estimated income tax and self-employment tax for the year. Then, add these together to find your total estimated tax liability. If this amount exceeds $1,000, you'll need to make quarterly tax payments. Divide your estimated tax liability by four to get your quarterly payment amount. Calculating this can be complex, but platforms like Found can simplify the process by updating your tax estimate in real-time with every new income or expense, so you’ll know what to expect when payments are due. Found Plus subscribers can send quarterly federal tax payments directly from the app.

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Calculate your tax bill the easy way with Found

There are a lot of different rules that go into calculating taxable income. But the biggest opportunities that you have for reducing your tax bill are deductions of any kind, so be sure to track any potential deductions carefully! Remember—your biggest deductions to track throughout the year are:

  • Business expenses

  • Adjustments

  • (if you plan to itemize) Below-the-line deductions like medical expenses and charitable contributions

Found can track your business expenses for you, so you don’t miss out on any deductions or leave money on the table. Download the Found app for free.

Disclaimer: The information on this website is not intended to provide, and should not be relied on, for tax advice. Tax laws vary by state, filing status, and other factors. 

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