As a contractor, you should set aside roughly 25% to 30% of your net income for federal taxes, and 30% to 40% once state and local taxes are added. Where you land inside that range depends on how much you earn, which deductions you qualify for, and the tax rules of the state and city you live in. Unlike a W-2 employee whose employer withholds taxes from every paycheck, you owe the full amount yourself and send it to the IRS in quarterly installments, so the percentage you pull off each client payment has to cover all of it.
Apply the Percentage to Net Profit, Not Gross Income
The percentage you set aside is calculated against net profit, which is what remains after you subtract legitimate business expenses from the total your clients paid you. Every valid expense you track reduces the income the IRS can tax, so accurate bookkeeping has a direct effect on how large the bill gets.
A business expense is deductible if it is ordinary and necessary for your work: software subscriptions, office supplies, professional development, business travel, business mileage at 72.5 cents per mile for 2026,1Internal Revenue Service. IRS Notice 2026-10 – 2026 Standard Mileage Rates a qualifying home office, and the business-use share of mixed expenses like a cell phone. Business meals are generally limited to 50% of the cost.2Internal Revenue Service. Income and Expenses 2 You report income and deductions on Schedule C, and the net profit becomes the starting point for both your self-employment tax and your income tax.3Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)
One note on income: for 2026, clients who pay you $2,000 or more are required to report those payments on Form 1099-NEC.4Internal Revenue Service. Form 1099-NEC and Independent Contractors That threshold does not change what you owe. You pay tax on every dollar earned whether a 1099 is issued or not.
The Three Taxes Your Set-Aside Has to Cover
Your percentage is really three stacked obligations. Understanding each one is how you know whether 25% is enough or you need to be closer to 40%.
Self-Employment Tax
This is the piece that surprises new contractors. W-2 employees split Social Security and Medicare taxes with their employer at 7.65% each. Self-employed, you pay both halves, a combined 15.3%: 12.4% for Social Security and 2.9% for Medicare.5Internal Revenue Service. Topic no. 751 – Social Security and Medicare Withholding Rates The IRS applies the 15.3% to 92.35% of your net earnings, not the full amount.6Internal Revenue Service. Topic no. 554, Self-Employment Tax
The 12.4% Social Security portion only applies to earnings up to the annual wage base, which is $184,500 for 2026.7Social Security Administration. Contribution and Benefit Base Above that cap, you still pay the 2.9% Medicare portion. Contractors earning above $200,000 (single) or $250,000 (married filing jointly) also pay an additional 0.9% Medicare surcharge on income above those thresholds.8Internal Revenue Service. Topic no. 560, Additional Medicare Tax You get to deduct half of your total SE tax as an adjustment to gross income, which lowers your income tax (though not your SE tax itself).
Federal Income Tax
After subtracting the half-SE deduction and either the standard deduction or itemized deductions, the remaining taxable income runs through the progressive federal brackets. For 2026, the standard deduction is $16,100 for single filers, $32,200 for joint filers, and $24,150 for heads of household.9Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 A single filer’s first $12,400 of taxable income is taxed at 10%; income from $12,401 to $50,400 at 12%; from $50,401 to $105,700 at 22%; and the brackets continue upward from there. Joint-filer brackets roughly double these thresholds. Only the income inside each bracket is taxed at that rate.
State and Local Taxes
Most states tax your net self-employment earnings, and some cities and counties add another layer. State rates range from around 2.5% to over 13%; a handful of states have no income tax. Local earnings taxes typically run 1% to 4%. If you live in a high-tax state, expect to add 5% to 10% on top of your federal set-aside percentage. Both state and local taxes generally use your federal Schedule C net profit as the starting point, though the deduction rules can differ, so check your state revenue department for exact rates and quarterly filing requirements.
Working Through the Numbers
Take a single filer with $80,000 in net self-employment income, no dependents, in a state with a 5% flat income tax:
- SE tax base: $80,000 × 92.35% = $73,880. At 15.3%, SE tax is about $11,304.
- Half-SE deduction: $5,652 reduces income subject to federal income tax.
- Qualified business income deduction: up to 20% of $80,000 = $16,000.
- Federal taxable income: $80,000 − $5,652 − $16,100 standard deduction − $16,000 QBI ≈ $42,248. Federal income tax lands around $4,900.
- State tax: roughly $3,700, depending on state-specific rules.
- Total: about $19,900, or roughly 25% of $80,000.
That 25% sits at the lower end of the range because the QBI deduction and standard deduction cover a sizable share of the income. The percentage climbs as income rises. A contractor earning $150,000 in net profit pushes into the 22% or 24% federal bracket, and combined federal plus state taxes can reach 35% or more of net income. Above $200,000, the additional Medicare surcharge kicks in, and QBI phase-outs may apply to service-based businesses, pushing total taxes above 40%.
A workable approach: run the math once for your own numbers using the components above, then round up by two or three points to build a buffer. The cushion absorbs income fluctuations and covers tax preparation fees. That final percentage is what you move out of every client payment the moment it clears.
Deductions That Lower the Amount You Owe
Three deductions are especially valuable to contractors and often get missed. Each one reduces the income your taxes are calculated against, which lowers the dollar amount you need in your set-aside account.
Self-Employed Health Insurance
If you pay for your own health insurance and are not eligible to join a plan through a spouse’s employer, you can deduct 100% of the premiums for yourself, your spouse, and your dependents. This is an above-the-line deduction, so it applies even if you take the standard deduction. The plan must be established under your business, though the policy can be in either the business name or your personal name.10Internal Revenue Service. Instructions for Form 7206 At $500 per month in premiums, that is $6,000 off your taxable income.
Qualified Business Income Deduction
The QBI deduction lets eligible self-employed taxpayers deduct up to 20% of net business income from taxable income. It phases out for certain service-based businesses (consulting, law, accounting) once taxable income exceeds roughly $200,000 for single filers or $400,000 for joint filers. Below those thresholds, you generally qualify for the full 20% regardless of industry. QBI reduces income tax only, not SE tax.
Retirement Contributions
Contributing to a self-employed retirement plan lowers taxable income while building savings. A SEP IRA allows contributions up to 25% of net self-employment earnings, with a maximum of $72,000 for 2026.11Internal Revenue Service. How Much Can I Contribute to My Self-Employed SEP Plan A solo 401(k) offers comparable limits with more flexibility through combined employee deferrals and employer profit-sharing. A $20,000 contribution on $100,000 of net profit drops taxable income to $80,000 before other deductions.
Credits also matter. The Child Tax Credit for 2026 is up to $2,200 per qualifying child,12Internal Revenue Service. Child Tax Credit and the Earned Income Tax Credit may apply depending on income and family size. Credits cut your tax dollar for dollar, so factor expected credits into your set-aside math or you will overestimate what you owe.
When to Send the Money In
The IRS runs on a pay-as-you-go system. You cannot hold everything until April. Four estimated payments are due during the year, each covering roughly a quarter of your expected liability. For 2026, the deadlines are April 15, June 16, September 15, and January 15, 2027.13Internal Revenue Service. Individuals – Estimated Tax Form 1040-ES includes the worksheet for estimating the year’s liability.14Internal Revenue Service. About Form 1040-ES, Estimated Tax for Individuals States generally have their own schedules.
Underpayment carries a penalty calculated as interest on the shortfall. You avoid it by meeting any one of three conditions: owing less than $1,000 after withholding and credits; paying at least 90% of your current-year tax; or paying at least 100% of last year’s tax, which rises to 110% if your prior-year adjusted gross income was above $150,000 ($75,000 if married filing separately).15Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty16Internal Revenue Service. Publication 505 – Tax Withholding and Estimated Tax The prior-year safe harbor is useful early on. If your income is growing fast, matching last year’s total (or 110% of it) shields you from penalties even if this year’s bill ends up much larger.
Hold the Money Somewhere You Will Not Touch It
The percentage only works if the money is still there in April. Open a separate savings account used exclusively for taxes. When a client payment lands, move your set-aside percentage into that account before you pay yourself or cover any expenses. Automating the transfer removes the temptation to borrow from it during a slow month.
This account is not your emergency fund and not a float for business costs. Treating it as untouchable is the single habit that separates contractors who sail through tax season from those scrambling in January. If money is consistently left over after all four quarterly payments, your percentage may be a point or two high. That is a much better problem than the alternative.