As a contractor, you should set aside about 25% to 30% of your net income for federal taxes, and 30% to 40% once state and local taxes are included. Where you land inside that range depends on how much you earn, what deductions you qualify for, and the tax rates in your state and city. Unlike a W-2 employee whose employer withholds tax from every paycheck, you owe the full amount yourself and send it to the IRS in quarterly installments. Setting the percentage too low means a surprise bill with penalties in April; setting it too high starves your cash flow all year.
Apply the Percentage to Net Profit, Not Gross Pay
The set-aside percentage works on your net profit, meaning what remains after you subtract legitimate business expenses from everything clients paid you. An expense is deductible if it’s ordinary in your line of work and necessary to run the business: software subscriptions, supplies, professional development, business travel, and so on. You can also deduct business mileage at 72.5 cents per mile for 2026,1Internal Revenue Service. IRS Notice 2026-10 – 2026 Standard Mileage Rates a home office if you use part of your home exclusively and regularly for work, and 50% of business meals.2Internal Revenue Service. Income and Expenses 2 All of this flows through Schedule C, and the net profit at the bottom is the number your taxes are built on.3Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)
One reporting note that trips people up: for 2026, clients only have to send you Form 1099-NEC if they paid you $2,000 or more during the year.4Internal Revenue Service. Form 1099-NEC and Independent Contractors You still owe taxes on every dollar you took in, whether or not a 1099 shows up. Track every payment yourself.
What Your Set-Aside Has to Cover
Three separate taxes come out of that net profit. Your percentage needs to cover all three.
Self-Employment Tax: 15.3%
This is the one that catches new contractors off guard. A W-2 employee splits Social Security and Medicare with their employer, each paying 7.65%. On your own, you pay both halves, for 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 15.3% doesn’t apply to your full net profit. The IRS runs it on 92.35% of net self-employment earnings.6Internal Revenue Service. Topic no. 554, Self-Employment Tax The 12.4% Social Security piece stops at $184,500 of earnings in 2026;7Social Security Administration. Contribution and Benefit Base the 2.9% Medicare piece keeps going. Once your income passes $200,000 (single) or $250,000 (married filing jointly), an extra 0.9% Medicare surcharge applies to the amount above the threshold.8Internal Revenue Service. Topic no. 560, Additional Medicare Tax
You do get to deduct half of your total SE tax as an adjustment on Form 1040. That doesn’t reduce the SE tax itself, but it lowers the income the federal income tax is calculated on.
Federal Income Tax
After subtracting the half-SE deduction, the standard deduction, and any other adjustments, you apply the federal brackets to what’s left. The standard deduction for 2026 is $16,100 for single filers, $32,200 for married filing jointly, and $24,150 for heads of household.9Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 The brackets are progressive: moving into the 22% bracket doesn’t mean all your income is taxed at 22%, only the income within that bracket.
Two deductions built for contractors keep the income-tax portion lower than most expect. The qualified business income (QBI) deduction lets eligible self-employed taxpayers deduct up to 20% of net business income, though it phases out for certain service businesses like consulting, law, and accounting once taxable income exceeds roughly $200,000 single or $400,000 joint. And if you pay for your own health insurance and aren’t eligible under a spouse’s plan, you can deduct 100% of the premiums for yourself, your spouse, and your dependents above the line, even if you take the standard deduction.10Internal Revenue Service. Instructions for Form 7206
Credits reduce the resulting tax dollar for dollar. The Child Tax Credit for 2026 is up to $2,200 per qualifying child,11Internal Revenue Service. Child Tax Credit and the Earned Income Tax Credit may apply depending on income and family size. If you expect credits, factor them in so you’re not oversaving.
State and Local Income Tax
This is where contractors most often come up short. State income tax rates run from around 2.5% to over 13%. Some states use a flat rate, some use progressive brackets, and a handful have no income tax at all. A number of cities and counties add their own income or earnings tax on top, typically 1% to 4%. If you live in a high-tax state, add 5% to 10% to your federal set-aside.
State and local taxes generally start from your Schedule C net profit, but the deduction rules can differ. Check your state revenue department for the current rates and any quarterly filing requirements.
A Worked Example
Put it together for 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%, roughly $11,304.
- Half-SE deduction: $5,652.
- QBI deduction: up to 20% of $80,000, or $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.
- Total: about $19,900, or 25% of $80,000.
That gets a mid-income contractor in a moderate-tax state to the low end of the 25%–30% federal-plus-state range.
Adjust Up for Higher Income
The percentage climbs as you earn more. A contractor with $150,000 in net profit will push into the 22% or 24% federal bracket, and combined federal and state taxes can easily reach 35% of net income. Above $200,000, the additional Medicare surcharge kicks in and QBI can start phasing out for service businesses, pushing the total past 40%. Contractors in high-tax states like California or New York should assume the top end of the range even at moderate income levels.
A practical approach: calculate your rate once using the example method with your own numbers, then round up by two or three points. That buffer absorbs income swings and covers tax prep at year-end. Transfer that percentage out of every client payment the moment it hits your account.
Where to Keep the Money and When to Send It
Open a separate savings account used only for taxes. When a client payment lands, move your set-aside percentage into it before you pay yourself or cover any expenses. If your rate is 30%, 30 cents of every dollar goes across immediately. Automating the transfer removes the temptation to borrow from it during a slow month. This isn’t your emergency fund and it isn’t a float for business costs. Treating it as untouchable is the single habit that separates contractors who sail through April from those hunting for $8,000 in January.
The IRS operates pay-as-you-go, so you send that money in four times a year using Form 1040-ES.12Internal Revenue Service. About Form 1040-ES, Estimated Tax for Individuals The 2026 due dates are April 15, June 16, September 15, and January 15, 2027, with weekend and holiday dates rolling to the next business day.13Internal Revenue Service. Individuals – Estimated Tax Most states run their own quarterly schedule alongside the federal one.
Safe Harbor: How to Never Owe a Penalty
If your quarterly payments come up short, the IRS charges a penalty computed as interest on the shortfall. You avoid it entirely by meeting any one of these:14Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty
- You owe less than $1,000 after withholding and credits.
- You paid at least 90% of what you owe on this year’s return.
- You paid at least 100% of last year’s total tax (110% if your prior-year AGI was above $150,000, or $75,000 married filing separately).15Internal Revenue Service. Publication 505 – Tax Withholding and Estimated Tax
The prior-year safe harbor is especially useful when your income is growing. Matching last year’s total tax (or 110% of it as a higher earner) shields you from penalties even if this year turns out much bigger. Many contractors lean on that rule the first year or two, then switch to the 90%-of-current-year method once income becomes easier to predict. If you end up with money left in the tax account after all four payments and the April filing, your percentage is slightly high. That’s a much better problem than the other one.