Consulting taxes explained

Being an independent consultant means wearing different hats. You've got to find clients, deliver the work and manage your finances. You do everything in your business.

And it's this juggling act that causes thousands to get their consulting taxes wrong. Usually, it involves overpaying or failing to claim deductible expenses. For an individual, that can mean thousands of dollars in lost income annually. In fact, some projections suggest it could be $5,000 or more of extra costs on their tax bill.

The worst bit? Many consultants don't even realize they can deduct certain expenses from their taxable income to give themselves immediate savings.

So in this article, you'll find out how to do taxes as an independent contractor, including what you can deduct, consulting income taxes you need to pay and tools to save thousands every year.

How a consultant is taxed differently from employees

A self employed consultant bears 100% of tax responsibility. This is very different from employees who have everything taken care of by their companies.

Here are the key differences you need to be aware of:

1. No automatic withholding

Employees who get a paycheck have their taxes withheld automatically. That means tax is taken out of their paycheck before they receive the money. They don't need to worry about anything.

Consultants don't have this automation. They get paid and need to work out their taxes later. This means failure to set aside money for your taxes could result in penalties, interest and charges when you can't pay your bills. Currently, the federal rate for underpaid taxes is the federal rate plus 3% added to your tax bill.

2. Double tax burden of self employment tax

New consultants often don't realize there is a double tax burden on them. As a consultant, you are liable to pay both sides of the coin. You have to pay the employee AND the employer portion of Social Security and Medicare taxes.

This results in about 15.3% tax on earnings. So it does feel more expensive than an employment tax. Although what employees might not realize is that their employer pays this tax on their behalf, which can have an indirect result on their take home pay.

3. Quarterly Payment Obligations

Consultants owing more than $1,000 in federal income taxes need to make estimated tax payments. These need to be submitted on April 15, June 15, September 15 and January 15 every quarter.

Essentially, you don't just pay your tax bill once a year. You pay quarterly. So you need to account for this in your forecasts, but it should help avoid a scary tax bill at the end of the financial year.

4. Deadlines and Forms

There are several forms consultants need to file, including Schedule C, Schedule SE and potentially State Returns by April 15th every year. If you miss the deadline, then failure to file penalties will be added at 5% per month (capped at 25%), plus there's a failure to pay penalty at 0.5%.

What makes you a consultant for tax purposes?

Whether or not you need to pay consultant tax depends on whether you are classed as an independent contractor.

The IRS has clear guidance on independent contractor classification. It's not about what you decide to call yourself. Instead, the IRS determines status based on the degree of control, financial arrangement and relationship type with the companies you work for.

A misclassification can mean you're liable for back taxes, penalties and interest if caught.

Here are the key factors:

• Behavioral control: The client tells you what to do, versus you controlling the methods

• Financial arrangement: You bear the risk, have multiple clients and set pricing

• Type of relationship: The permanence, benefits eligibility and contract specificity

Often, companies illegally misclassify employees as contractors to try to avoid payroll taxes. And just because you are called a 1099 contractor or get paid via the 1099 system doesn't legally make you a contractor.

Income reporting requirements for independent consultant taxes

Getting your taxes right as a self-employed person is perhaps the most complicated part of running your own business. Often, you might not even be able to afford an accountant to do it for you. Even if you do have an accountant, it's best to understand the process since you are liable for everything that goes on.

Forms and thresholds

Consultants should receive 1099-NEC forms that show non employee compensation. This is different from a W-2, which employees get. It doesn't show tax withholding or how much you should pay. 

Even if you don't receive a 1099, you still need to report all your income on time. That includes:

• Cash payments

• Multiple small clients

• Side work

• Crypto income

• Anything else of value

The IRS has eyes everywhere. They're able to match income with banks, PayPal, Stripe and compare 1099s submitted by companies and consultants.

If you fail to properly track your income and report all your sources, it will severely increase audit risk and future problems. 

Income tax brackets for the self employed

It's best practice to put money from income aside for tax. Many consultants do this on every single payment to make sure they're never caught short.

To do this, you'll need to know your federal tax rate based on your tax bracket, as this can range from anywhere between 10% and 37%.

In 2025, brackets start at 10% for income under $11,925 through to 37% for income above $626,351.

How is your income calculated?

Before you start working out your taxable income, you should understand the math behind it. It's not done on total revenue. Rather, you take gross revenue and subtract business deductions.

For example, if you received $100,000 in revenue but you had $30,000 of allowable expenses, your taxable income would be $70,000. And that's the figure that would be subject to tax.

So the more organized you are with your expenses and deductions, the lower your taxable income. That means more money in your own pocket.

Planning for higher tax brackets

You should also think about your consulting income increasing and decreasing over the years. If you keep earning more money, you might move into a higher tax bracket. If this happens at any point, then the additional dollars you earn are taxed at a higher rate.

Forecasting this and using strategic deductions along with retirement contributions can be effective in balancing this problem.

To give you an example, a difference between a 22% and 24% tax bracket can be significant. If you were to include an extra $5,000 in deductions between these brackets, it could save you over $1,000. So don't be afraid to time significant expenses to stay more tax effective.

State and local taxes

States have tax variations. For example, did you know that 42 states collect income tax?

That's good news if you're in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington or Wyoming. These states have no income tax.

It's a disadvantage for consultants who sit in high tax states like California, New York, Illinois or New Jersey. With California being the highest, combined federal and state tax rates can exceed 50%.

Wherever you're operating your business from, you should know the specific state rules. In most states, sales tax isn't charged on professional consulting services.

If you're wondering what happens if you have clients in multiple states… then you're right in thinking that you might owe taxes in every state where you have a presence (aka a nexus). So multi-state planning becomes necessary if you have a national or international client base.

Business deductions available for consultants

Now, on to the good stuff. Tax tips for independent contractors to reduce your consultant taxes.

The beauty of being self employed is that you can claim business expenses for all manner of things. These are known as deductions and they span home offices, vehicles, professional development and even software.

Let's go through some of the most common ones.

Home office

If you work from home and you have a dedicated space that's used regularly and exclusively for business, then you can use this as a deduction.

Exclusive use is a strict policy, not occasional use. For example, using your dining table for work every now and then doesn't qualify. You need a defined area.

To calculate it, you can measure the space. For example, a 200 square foot office multiplied by $5 would equal a $1,000 deduction. This is a simple way to do it.

Alternatively, you can calculate the percentage of your home used for business and deduct that percentage from your home expenses. That can provide larger deductions and can help deduct rent and mortgage costs, utilities, insurance and repairs.

You should also track your utilities like electricity, water, internet and phone bills, as these can be added to expenses and will quickly add up to at least $2,000-$3,000 in many cases.

Business equipment and technology

You need physical items to actually run your business. So any office furniture and supplies can be expensed. Think desks, chairs and filing cabinets. Even printers and printer ink are all deductible and work as immediate writeoffs, so you can free up cash.

In addition, all your tech (computers, laptops, phones) can be deductible, along with the software running on them. So if you use Microsoft Office, Adobe Creative Suite or accounting software, that's all an expense for your business that should be deducted.

For most things, it will be an immediate deduction known as Section 179. Although for larger purchases (usually several hundred thousand or millions of dollars), you could depreciate the equipment over time to offset tax over multiple years.

Vehicles and travel expenses

If you need to travel specifically for work, then there are particular rules that apply. Most consultants use their everyday car to get around, but you can use mileage at 70 cents per mile when going to meetings, offices or coworking spaces.

So if you drive 25,000 business miles a year… 25,000 x 70 cents would be a $17,500 deduction. Handy.

You can also use the vehicle operating expense method, where you can deduct actual vehicle costs: gas, insurance, repair and depreciation. This is particularly useful if your car is older or has high mileage and actual expenses exceed your standard mileage rate. So you need to decide which method to use.

Of course, if you're using public transport, flights, car rentals and hotels for business, those are all deductible professional expenses.

It's worth noting that meals while traveling for business or with clients are deductible, but only 50%. So if you have a $100 meal with a client, you can only deduct $50.

Remember, make sure to document all of this travel information. You need receipts, credit card statements and mileage logs to substantiate everything. If you don't have the documentation and you're audited, the IRS will likely disallow your claimed deductions.

Business services and professional fees

If you've got an accountant looking after your finances, then they should make you aware of everything. But these services, too, are tax-deductible, whether it's tax software, bookkeeping services or legal services.

Even marketing and advertising expenses count. If you're spending money on content creation, web design or SEO, then these are all costs to your business that shouldn't be taxed.

Common consulting tax mistakes

If this is your first time investigating what you need to pay as a consultant, then you've probably realized that things can get quite complicated. And it's that complexity that leads to some widespread mistakes that independent contractors make.

Here's what you need to watch out for:

Not tracking expenses properly

As a busy solo business, you might be tempted not to keep receipts or even mix personal and business finances. This creates a big problem.

If you don't have evidence of your expenses, then you can't prove legitimate deductions to the IRS. If you're audited, this will hurt you and often cause disallowed deduction costs that result in tax penalties and interest.

It's also easy to mix personal and business finances if you're using a personal checking account for business expenses and income. It's best practice to separate business accounts and personal accounts, so you have a clear audit trail and professional separation of your money.

The IRS sees a commingled account as a higher audit risk.

It's worth noting that if you do lose records, the IRS does allow you to reconstruct records as best as possible using bank statements, credit cards and witness statements. But this is a last resort.

Missing quarterly payment deadlines

If you're late in filing your quarterly taxes, then this triggers an underpayment automatically. So don't leave them until the last minute.

Underpayment penalties can average 4-8% annually and worse still, they compound quarterly, so it can create a horrible cycle.

Forgetting to report all income

If you're sloppy with your record keeping, then it doesn't just harm deductions. You might forget to report certain income.

For example, if you've got income from multiple sources, then you need to track these closely. As a consultant, you might get paid into a bank account, into a PayPal account, in crypto or even in cash. It all counts as income and failing to report it is tax evasion, not just avoidance.

You might think that cash isn't trackable, but the IRS is wise to this and has sophisticated detection methods. The IRS even goes as far as data matching between payment platforms like PayPal, Stripe, Square and Venmo and 1099 reports.

Over-claiming deductions

You might get tempted to play fast and loose with your deductions, but the IRS has audit trigger thresholds for unusually high deduction to income ratios. This especially applies to home office and vehicle deductions.

So if you're throwing all of your vehicle mileage on as a business expense, then that's an extra risk.

Anything you add as a deduction, you need to substantiate with receipts, records and documentation. Without this, even legitimate deductions can be disallowed.

Simplify consultant payments and taxes with Acctual

The most successful consultants use payment systems like Acctual. 

If you're looking to track and manage your payments effectively, then Acctual is the best place to do this. 

In fact, it doesn't just help with your tax reporting; it even allows you to create and track invoices for your consulting.

It removes all of the manual burden, allowing you to invoice clients anywhere in the world with flexible payment options. Clients can pay however they like and you can get paid however you like.

If you prefer working in stablecoins but your client prefers to pay in fiat currency, that's no problem… You can invoice the client in US dollars and get paid into your USDC wallet. Or vice versa. Acctual takes care of everything in between.

Plus, to make tax season effortless, everything integrates with your accounting and ERP software.

Take 2 minutes to set up a free Acctual account today.