Self-employment changes your tax situation significantly. You're responsible for taxes that employers typically handle, but you also gain access to deductions that W-2 employees can't claim.
This guide covers what self-employed contractors need to know about taxes: tracking income and expenses, claiming deductions, making quarterly payments, and working with tax professionals.
Disclaimer: This guide provides general information. Tax situations vary. Consult a tax professional for advice specific to your circumstances.
The Fundamental Difference: Self-Employment Tax
When you're self-employed, you pay both the employee and employer portions of Social Security and Medicare taxes. This is called self-employment tax.
W-2 employees pay: 7.65% (employee portion) Employers pay: 7.65% (employer portion) Total: 15.3%
Self-employed contractors pay: 15.3% (both portions)
This applies to your net self-employment income (revenue minus business expenses).
Example:
- Revenue: $100,000
- Business expenses: $25,000
- Net income: $75,000
- Self-employment tax: $75,000 × 15.3% = $11,475
On top of this, you also pay regular income tax based on your tax bracket.
What You Can Deduct
Business expenses reduce your taxable income. The IRS allows deductions for expenses that are "ordinary and necessary" for your trade.
Vehicle Expenses
If you use your vehicle for business, you can deduct vehicle costs using one of two methods:
Standard mileage rate (2026: $0.70/mile):
- Track business miles driven
- Multiply by IRS standard rate
- Simple but may understate actual costs for older vehicles
Actual expenses:
- Track all vehicle costs (gas, insurance, repairs, depreciation)
- Deduct the business-use percentage
- More work but often yields higher deduction
Example (standard mileage):
- Business miles driven: 15,000
- Deduction: 15,000 × $0.70 = $10,500
Example (actual expenses):
- Total vehicle expenses: $8,000
- Business use: 75%
- Deduction: $8,000 × 75% = $6,000
Most contractors use standard mileage for simplicity, but run both calculations to see which benefits you more.
Home Office
If you use part of your home exclusively for business, you can deduct home office expenses.
Requirements:
- Must be used regularly and exclusively for business
- Must be your principal place of business
Simplified method:
- $5 per square foot, up to 300 square feet
- Maximum deduction: $1,500
- No additional record-keeping required
Regular method:
- Calculate percentage of home used for business
- Deduct that percentage of: mortgage interest or rent, utilities, insurance, repairs, depreciation
Example (regular method):
- Home: 2,000 sq ft
- Office: 200 sq ft (10% of home)
- Annual home expenses: $24,000
- Deduction: $24,000 × 10% = $2,400
Tools and Equipment
Tools and equipment used in your business are fully deductible.
Under $2,500 per item: Can be deducted immediately in the year purchased.
Over $2,500: May need to be depreciated over several years (consult tax professional for specifics).
Examples of deductible items:
- Power tools
- Hand tools
- Ladders and scaffolding
- Safety equipment
- Diagnostic equipment
- Computer and software for business use
Materials and Supplies
Materials purchased for jobs are fully deductible when purchased or when used (depending on your accounting method).
This includes:
- Lumber, pipe, wire, and other raw materials
- Fixtures and fittings
- Paint, sealant, and finishing materials
- Fasteners and hardware
Keep receipts organized by job to track which materials went to which project.
Phone and Internet
If you use your phone and internet for business, you can deduct the business-use percentage.
Example:
- Monthly phone bill: $100
- Business use: 50%
- Annual deduction: $100 × 12 months × 50% = $600
If you have a dedicated business line, the entire cost is deductible.
Business Insurance
All business insurance premiums are deductible:
- Liability insurance
- Workers' compensation
- Commercial vehicle insurance
- Professional liability (errors & omissions)
- Business property insurance
License and Permit Fees
Deduct costs for:
- Business licenses
- Trade licenses
- Building permits (job-specific permits)
- Professional certifications and renewals
Software and Subscriptions
Business software subscriptions are deductible:
- Quoting and invoicing software
- Accounting software
- Project management tools
- Industry-specific software
- Cloud storage for business files
Continuing Education
Training and education to maintain or improve skills in your current trade is deductible:
- Trade school courses
- Safety certification classes
- Software training
- Industry conferences and seminars
Note: Education that qualifies you for a new trade or profession is generally not deductible.
Advertising and Marketing
Marketing expenses are fully deductible:
- Website hosting and design
- Business cards and flyers
- Vehicle wraps or lettering
- Online advertising
- Directory listings
Professional Services
Fees paid to professionals for business purposes:
- Accounting and bookkeeping
- Legal advice
- Business consulting
- Tax preparation fees
Interest on Business Loans
Interest on loans used for business purposes is deductible. This includes:
- Business credit cards (business purchases only)
- Equipment loans
- Business line of credit
- Contractor financing
Keep personal and business expenses separate to make this easier to track.
What You Cannot Deduct
Some expenses feel business-related but aren't deductible:
Commute to your first job of the day: Travel from home to your first work site isn't deductible. Travel between job sites during the day is deductible.
Personal use of business assets: If you use your work truck for personal errands, that portion isn't deductible.
Fines and penalties: Traffic tickets, permit violation fines, and similar penalties are never deductible.
Personal meals: Your lunch is only deductible if you're meeting with a client or at a business event. Regular daily meals aren't deductible.
Clothing: Work clothes are only deductible if they're not suitable for everyday wear (uniforms, protective gear). Regular jeans and boots aren't deductible even if you only wear them for work.
Record-Keeping Systems
The IRS requires documentation for all deductions. Your records should prove:
- The expense occurred
- The amount
- The business purpose
- The date
What to Keep
Receipts: Keep all business receipts, either physical or digital. Apps like Expensify or QuickBooks can photograph and categorize receipts automatically.
Mileage logs: Record date, starting location, destination, miles driven, and business purpose. Apps like MileIQ can track this automatically using GPS.
Bank statements: Maintain separate business bank account and credit card. This creates a clear boundary between business and personal expenses.
Invoices and quotes: Keep copies of all quotes sent and invoices issued. This documents your revenue and helps track which expenses relate to which jobs.
How Long to Keep Records
Tax returns: Indefinitely Supporting documents (receipts, logs, etc.): 3-7 years Employment tax records: 4 years Asset records (for depreciation): Until asset is disposed of, plus 3 years
Most contractors keep everything for at least 7 years to be safe.
Quarterly Estimated Taxes
Unlike W-2 employees who have taxes withheld from every paycheck, self-employed contractors must make quarterly estimated tax payments.
Payment Schedule
Taxes are due four times per year:
- Q1 (Jan 1 - Mar 31): Due April 15
- Q2 (Apr 1 - May 31): Due June 15
- Q3 (Jun 1 - Aug 31): Due September 15
- Q4 (Sep 1 - Dec 31): Due January 15 (following year)
How Much to Pay
You're expected to pay the lower of:
- 90% of current year's tax liability, or
- 100% of previous year's tax liability (110% if income over $150,000)
Simple estimation method:
- Estimate your annual profit (revenue minus expenses)
- Calculate self-employment tax (profit × 15.3%)
- Calculate income tax based on your bracket
- Divide total by 4 for quarterly payment amount
Example:
- Estimated annual profit: $80,000
- Self-employment tax: $80,000 × 15.3% = $12,240
- Income tax (assume 22% bracket): $80,000 × 22% = $17,600
- Total estimated tax: $29,840
- Quarterly payment: $29,840 ÷ 4 = $7,460
Penalties for Underpayment
If you don't pay enough in quarterly taxes, you may owe penalties when you file your annual return. The penalty is typically modest (a few hundred dollars) unless the underpayment is severe.
To avoid penalties:
- Pay at least 90% of what you'll owe for the current year, or
- Pay 100% of last year's tax (110% if high income)
Retirement Accounts for Self-Employed Contractors
Contributing to retirement accounts reduces your taxable income while building savings.
SEP IRA (Simplified Employee Pension)
Contribution limit (2026): Up to 25% of net self-employment income, maximum $69,000
Pros:
- Simple to set up
- High contribution limits
- Contributions are tax-deductible
Cons:
- If you have employees, you must contribute equivalent percentage to their accounts
- No catch-up contributions
Solo 401(k)
Contribution limit (2026): $69,000 (or $76,500 if age 50+)
Pros:
- Highest contribution limits
- Can contribute as both employee and employer
- Allows catch-up contributions
Cons:
- More complex to set up and administer
- If you have employees, they become eligible after 1 year
Traditional IRA
Contribution limit (2026): $7,000 ($8,000 if age 50+)
Pros:
- Simple to set up
- Available to anyone
- Contributions may be tax-deductible
Cons:
- Low contribution limits compared to SEP or Solo 401(k)
- Deduction may be limited if you have access to employer plan
Most self-employed contractors use either a SEP IRA or Solo 401(k) for the higher contribution limits.
Working with a Tax Professional
While you can file taxes yourself, working with a tax professional often saves more than it costs.
When to Hire a Tax Professional
Consider hiring help if:
- You have complex deductions (home office, vehicle depreciation)
- Your income exceeds $75,000-$100,000
- You have employees or subcontractors
- You're not confident in your tax knowledge
- You've never filed self-employment taxes before
What to Look For
Enrolled Agent (EA): Licensed by the IRS, specializes in taxes. Good choice for most contractors.
CPA (Certified Public Accountant): Licensed accountant, can also help with business strategy beyond just taxes. More expensive but valuable if you're growing.
Don't use: Unlicensed "tax preparers" or seasonal tax prep chains for complex self-employment situations.
Costs
Expect to pay:
- Tax preparation: $300-$1,000 for Schedule C (self-employment)
- Bookkeeping: $100-$300/month if you hire it out
- Annual consulting: $500-$2,000 for strategic tax planning
These fees are tax-deductible business expenses.
Common Tax Mistakes Contractors Make
Mixing Personal and Business Expenses
Using the same bank account and credit card for both creates a record-keeping nightmare. Open separate business accounts.
Not Tracking Mileage
Vehicle expenses often represent one of the largest deductions. Failing to track mileage leaves money on the table. Use a mileage tracking app.
Forgetting to Make Quarterly Payments
Waiting until April to pay all your taxes triggers penalties. Set reminders for quarterly deadlines.
Classifying Workers Incorrectly
If you hire help, understand the difference between employees and independent contractors. Misclassification can result in back taxes and penalties.
Not Saving Receipts
You can't claim deductions without documentation. Save every receipt, either physical or digital.
Deducting Personal Expenses
The IRS audits self-employed taxpayers at higher rates than W-2 employees. Only deduct legitimate business expenses with proper documentation.
Tax Planning Strategies
Beyond basic compliance, strategic tax planning can reduce your tax burden:
Timing Income and Expenses
If you're near a tax bracket threshold, consider:
- Deferring income to next year (delay invoicing in December)
- Accelerating expenses to current year (buy equipment in December instead of January)
This works best if you expect similar income next year.
Maximizing Retirement Contributions
Retirement contributions reduce taxable income. If you have extra cash in a profitable year, increase retirement contributions to lower your tax bill.
Hiring Family Members
Hiring your spouse or children for legitimate business work can shift income to lower tax brackets. Rules vary, so consult a tax professional.
Entity Structure
Most contractors start as sole proprietors, but as income grows, forming an LLC or S-Corp can provide tax benefits. This is worth discussing with a CPA when your profit exceeds $60,000-$80,000.
The Bottom Line
Self-employment taxes are more complex than W-2 withholding, but understanding the basics keeps you compliant and helps you keep more of what you earn.
Track all business expenses, make quarterly estimated payments, keep good records, and don't hesitate to hire professional help when the complexity exceeds your comfort level.
The contractors who manage taxes well treat it as an ongoing process, not an annual scramble. Set aside money for taxes with each payment you receive (30-35% is a safe rule of thumb), track expenses as they happen, and review your situation quarterly.
Tax preparation isn't exciting, but it's one of the most leveraged activities in your business. A few hours spent understanding deductions and planning strategically can save thousands of dollars per year.
Track business expenses automatically. Try SemaQuote free and export organized expense reports for tax time. Every quote and invoice creates a transaction record you can use for tax preparation.
