Are you bringing in some extra cash through a side hustle or gig work? If so, it’s important to understand your tax obligations.
Side hustle taxes can be confusing, but with the right information and planning, you can avoid unnecessary stress and headaches come tax season.
From understanding the difference between W-2 and 1099 forms to taking advantage of tax deductions for your business expenses, there are steps you can take to manage your side hustle taxes like a pro.
So, whether you’re new to gig work or a seasoned pro looking for tips and tricks, keep reading to learn everything you need to know about managing your side hustle taxes!
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Understanding Side Hustle Taxes
Side hustles are a common way to earn extra income, but it’s important to understand the tax obligations that come with them. You should know the differences between the various forms and understand hobby versus business income.
We will also look at some best practices you can adopt to make calculating and paying your taxes much easier.
Let’s dive in:
Defining A Side Hustle
A side hustle is any type of work you do outside your full-time job to earn additional income. This can range from selling items online or performing freelance services to renting out a property or driving for a ride-sharing service.
Side hustles are becoming increasingly popular, especially with the rise of the gig economy and flexible work arrangements. A new survey of over 1,000 Americans finds a whopping 93% of Americans who are currently working part-time or full-time have a side hustle. However, it’s important to understand that even if it’s just extra cash on the side, you are still required to pay taxes on your earnings.
In terms of tax obligations, having a side hustle means that you are considered self-employed by the IRS. This means you will need to pay self-employment taxes in addition to federal and state income taxes on your net earnings from your side hustle.
It’s important to note that even if you only make a few hundred bucks through your side gig (typically more than $400), you may still owe taxes on those earnings. Understanding these tax obligations is crucial for anyone considering starting a side hustle or already earning income from one.
Tax Obligations For Side Hustles
If you have a side hustle, you are responsible for paying taxes on your earnings. This means that you need to report all of your income from your side gig and pay the appropriate amount of taxes. Depending on how much money you make, you may need to file quarterly tax payments throughout the year.
As a self-employed individual, you’ll not only be responsible for Federal income tax but also self-employment tax which includes social security and medicare taxes. It’s important to keep track of all your earnings and expenses associated with your side hustle so that when it comes time to file your taxes, you can accurately calculate your net earnings. Failure to do so could result in penalties or fines from the IRS.
Differences Between W-2 And 1099 Forms
W-2 and 1099 forms are used to report income, but they are different in terms of who issues them and what type of income they report. A W-2 form is issued by an employer to an employee, reporting their wages for the year, including any taxes withheld.
On the other hand, a 1099 form is issued by a client or company that has paid an independent contractor over $600 during the tax year.
There are many types of Form 1099 for various uses when handling self employment income. Before 2020, for a side hustle (nonemployee payments or payments to independent contractors), you would use Form 1099-MISC. Now you use Form 1099-NEC: Nonemployee Compensation.
These forms generally report business payments—not personal ones. This form reports nonemployee compensation and does not have taxes withheld.
It’s important to understand which form you will receive based on your side hustle arrangement so you can properly report your income on your tax return. Independent contractors who receive a 1099 form need to make sure they set aside enough money to cover self-employment taxes since taxes aren’t automatically withheld like with W-2 employees. It’s crucial for you to keep accurate records of all income received throughout the year from various sources so you can properly file your taxes come tax season.
Hobby Vs. Business Income
One important aspect of understanding side hustle taxes is determining whether your income should be classified as hobby or business income. The IRS distinguishes between a hobby and a business based on factors such as profit motive, time and effort expended, and whether the activity is conducted in a professional manner.
If your side hustle is deemed to be a legitimate business, you may be eligible for tax deductions related to expenses such as supplies or equipment.
It’s important to note that if your side hustle falls under the category of hobby income rather than business income, you will still need to report it on your tax return but may not be able to deduct all of your expenses. It’s crucial to keep accurate records and consult with a tax professional if you’re unsure about how your earnings should be classified. Failing to correctly classify your earnings can result in penalties from the IRS down the line.
Types of Taxes to Consider
When it comes to side hustle taxes, there are several types of taxes that you need to consider.
- Self-employment tax. These are the Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes (12.4% for Social Security and 2.9% for Medicare).
- Federal income taxes. Federal income tax is money you pay to the federal government for earned income.
- State income tax. Some states don’t have an income tax. However, if you live in a state with an income tax, you have to incorporate it in your calculations.
Finally, if you’re selling physical products as part of your side hustle, then sales tax may also come into play. Keep in mind that sales tax rules vary by state and even by city or county so it’s important to do your research and make sure you’re collecting and remitting the correct amount of sales tax.
As a side hustler, you may wonder if you need to file taxes on your additional income. The answer is yes. If your net earnings from self-employment were $400 or more, you’ll need to file an income tax return. Keep in mind that even if your side hustle does not generate much income, it still needs to be reported on your tax return.
The filing requirements for side hustle taxes typically depend on the type of business structure and the amount of income earned. For example, if you’re self-employed as a sole proprietor and earn less than $400 in net profit, you don’t have to file federal taxes but may still need to report the earnings on state or local tax forms. It’s important to check with a tax professional or utilize resources from the IRS website for guidance on specific filing requirements based on your unique situation.
Estimating Quarterly Taxes
Quarterly self-employment taxes are what pay each quarter of the year based on estimated tax liability. Ideally, you pay a quarter of what you owe each quarter.
Estimating quarterly taxes is an important part of managing your side hustle finances. If you expect to owe $1,000 or more in taxes for the year from your side hustle income, the IRS requires you to make estimated tax payments four times a year. These payments are due on April 15th, June 15th, September 15th, and January 15th.
To determine estimated taxes each quarter, use Form 1040-ES provided by the IRS. This form will help you calculate your expected income and tax liability for the year based on your profits from previous quarters. Remember that it’s better to overestimate than underestimate your earnings to avoid penalties or interest charges later on.
You can be exempted from quarterly payments if (besides owing less than $1,000):
- You didn’t have to file a tax return in the previous year.
- You withhold at least 90% of the total you will owe for the year
- You withhold at least 100% of the total tax paid on last year’s return.
With proper planning and organization, estimating and paying quarterly taxes can be stress-free and manageable while keeping track of all the paperwork that comes with it!
Deductions And Credits For Side Hustle Taxes
As a side hustler, you may be eligible for tax deductions and credits that can lower your tax bill. From home office expenses to retirement savings options, there are plenty of ways to save money on your taxes while running your business. Keep reading to learn more about the legal deductions and credits for your side hustle taxes.
Home Office Expenses
If you use a dedicated space in your home solely for your side hustle, you may be able to deduct a portion of your mortgage or rent, utilities and other qualifying expenses. Keep in mind there are specific requirements that must be met to qualify for this deduction.
To take advantage of the home office deduction, the IRS requires that the space be used regularly and exclusively for business purposes. This means if you only work on your side hustle several times a month from your kitchen table, you likely won’t qualify. However, if you have a designated room or area where all business activities occur – such as taking orders or keeping inventory – then it’s worth looking into this potential tax break.
If it gets too complex, you can use the safe harbor method to deduct $5 per square foot up to 300 square feet.
Supplies And Equipment
Supplies and equipment can be a significant expense, but fortunately, many of these costs can be deducted from your taxes. This includes everything from office supplies and software to tools and machinery needed to run your business. Keep track of all invoices and receipts related to these expenses so that you have documentation come tax time.
However, it’s important to note that not all supplies are tax-deductible. Items that are considered personal or used for both personal and business purposes may not be eligible. For example, if you purchase a laptop for both work and entertainment purposes, only the portion used for work can be deducted as a business expense. Be sure to consult with a tax professional or utilize tax software to ensure that you’re accurately deducting eligible expenses while avoiding mistakes or penalties.
Side hustles that require a vehicle, such as ridesharing or delivery services, can rack up expenses quickly. Thankfully, some of these costs may be deductible on your taxes. Keep detailed records of all business-related vehicle expenses, including gas, maintenance and repairs. Additionally, if you use your car for both personal and business purposes, only the business portion is deductible.
When calculating your vehicle deductions for taxes, there are two different methods to choose from: actual expense method or standard mileage rate method. The actual expense method involves tracking all vehicle-related costs throughout the year while the standard mileage rate method allows for a fixed amount per mile driven for business purposes. It’s important to consider which option is best suited for your specific situation in order to maximize tax savings while remaining compliant with IRS regulations.
Retirement Savings Options
As a side hustler, saving for retirement may not be at the top of your list. However, it’s important to consider how you’ll support yourself in the future. One option is setting up a Simplified Employee Pension (SEP) IRA or Solo 401(k). Both allow you to contribute pre-tax earnings and can help lower your taxable income.
Another option is opening an Individual Retirement Account (IRA), which allows you to invest in stocks, bonds, and funds with tax-deferred growth potential. You can contribute up to $6,000 per year if under age 50 or $7,000 if over 50 years old. Don’t forget about the Saver’s Credit when filing taxes; taxpayers making less than $32K ($64K if married filing jointly) are eligible for this credit worth up to $1,000.
By thinking ahead and investing in a retirement savings account now, you’ll be able to reap the benefits down the road while also lowering your current tax liability. Plus, saving even just a few hundred bucks each month can compound into significant savings by retirement age!
Other Potential Deductions And Credits
Aside from home office expenses, supplies and equipment, and vehicle expenses, there are other potential deductions and credits that gig workers can take advantage of when filing their taxes. For example, some business-related education or training expenses may also be deductible.
It’s important to keep track of all legitimate business expenses throughout the year in order to maximize their deductions come tax time. This can include costs associated with advertising, professional memberships or subscriptions, and travel expenses related to attending conferences or networking events.
Tips For Managing Side Hustle Taxes
To stay organized with your taxes, here are some helpful tips:
Keep Detailed Records
Keeping detailed records is crucial when it comes to managing your side hustle taxes. Not only will it help you accurately report your income and expenses, but it can also make tax season a lot less stressful. Keep track of all receipts, invoices, and bank statements related to your side hustle.
In addition to physical record-keeping, there are several tools available online that can help simplify the process. Many accounting software programs offer features specifically designed for small business owners and freelancers. Utilizing these resources can help ensure that you have everything you need come tax time.
Set Aside Money For Taxes
When it comes to side hustle taxes, one of the most important things you can do is set aside money for them. Ideally, you should be putting away 20-35% of your earnings in anticipation of tax season. This can help prevent a financial shock when it’s time to pay up.
Not sure how much you need to save? A good rule of thumb is to estimate what your tax liability will be and divide that by the number of pay periods you have before taxes are due. However, keep in mind that this method isn’t foolproof – unexpected changes to tax laws or income levels could affect your final bill. That’s why some people prefer to err on the safe side and save even more than they think they’ll need.
Utilize Tax Software Or Hire A Professional
Utilizing tax software or hiring a professional can be helpful when it comes to managing your side hustle taxes. Tax software like TurboTax and H&R Block can assist with calculating estimated payments, deductions, and filling out forms correctly. These programs provide you with step-by-step guidance to ensure that you don’t miss anything important.
However, if your side hustle is more complex, such as if you have several sources of income or significant business expenses, it may be best to hire a tax professional. A certified public accountant (CPA) or enrolled agent (EA) can help ensure that all of your taxes are filed accurately and on time while minimizing any potential audits from the IRS. Keep in mind that hiring a professional may cost more than using tax software but could save money in the long run by avoiding errors or penalties.
Separate Personal And Business Finances
One of the most important tips for managing your side hustle taxes is to keep your personal and business finances separate. This means having a dedicated bank account for all of your business income and expenses. Not only does this make it easier to track your earnings and deductions, but it also helps you avoid potential legal issues by keeping everything organized.
If you use a credit card for business expenses, consider getting a separate one solely for those transactions. This can help prevent any confusion or mixing up of personal and business charges on the same statement. By separating your finances, you can ensure that you’re accurately reporting all income and expenses come tax season – which means avoiding potential penalties or audits from the IRS down the line!
Common Mistakes To Avoid When Filing Side Hustle Taxes
Let’s take a look at some of the most common mistakes people make when filing taxes for their side hustle income:
Failing To Report All Income
One of the biggest mistakes you can make when it comes to your side hustle taxes is failing to report all of your income. It’s easy to think that just because you made a few extra dollars here and there, you don’t need to include it on your tax return. However, even small amounts of income must be reported or else you could face significant penalties from the IRS.
In fact, if you fail to report all of your income, the consequences can be severe. You may end up owing back taxes, interest charges, and even fines for not complying with tax laws. It’s important to keep accurate records throughout the year so that nothing falls through the cracks come tax season.
Incorrectly Classifying Income
One of the common mistakes people make when filing their side hustle taxes is incorrectly classifying their income. It’s important to differentiate between hobby and business income as they have different tax implications. Hobby income is not subject to self-employment tax or deductible expenses, while business income is.
Incorrectly classifying your income can result in overpaying or underpaying taxes. It’s important to keep detailed records of all income earned from your side hustle and accurately classify it as either hobby or business income. If you’re unsure, consult with a tax professional for guidance on properly categorizing your earnings.
Mixing Personal And Business Finances
Mixing personal and business finances can lead to confusion when it comes time to file taxes for your side hustle. It’s important to keep these two types of finances separate in order to accurately track income and expenses. This will also help you take advantage of any deductions or credits that may be available for your side hustle.
Failing To Take Deductions
Failing to take deductions can be a costly mistake when it comes to side hustle taxes. Deductions can help lower your taxable income and reduce the amount of tax you owe. Some common deductions for side hustles include home office expenses, supplies and equipment, vehicle expenses, retirement savings options and more. Failing to claim these legitimate business expenses could mean missing out on significant tax savings.
It’s important to keep accurate records of your business expenses so you don’t miss any potential deductions. This can include receipts for supplies, invoices for services or tools purchased, as well as keeping track of mileage if you use your vehicle for business purposes. Additionally, hiring a certified financial planner or tax professional may also help ensure that you are taking all possible deductions that apply to your specific type of side hustle work.
Claiming the wrong dependents
You can list your children as dependents or relatives if they rely on you financially but not your spouse. If your parents list you as a dependent, you can’t list your child a dependent.
Filing Taxes last minute
First, you should not miss the tax deadline to avoid incurring extra costs in penalties. Also pay in time and avoid the last minute rush.
Since the internet exists, it is easier to file taxes online than offline (on paper) because it is easier to do so on the internet. If you file offline, you may not take advantage of some of the software apps that help with the process. Another benefit of doing the process online is that you get an automatic confirmation from the IRS.
To add to that, it is easier to pay your taxes via the bank or with a credit card than by sending a check.
In conclusion, managing your side hustle taxes can seem overwhelming, but it doesn’t have to be. By understanding the tax obligations for side hustles and taking advantage of available deductions and credits, you can help reduce your tax liability.
It’s crucial to keep detailed records, estimate quarterly taxes, and separate personal and business finances. Avoid common mistakes like failing to report all income or mixing personal and business expenses.
Don’t hesitate to seek the guidance of a tax professional or utilize helpful tax software. By staying on top of your side hustle taxes, you’ll ensure that you’re in compliance with federal and state regulations while keeping more money in your pocket for those extra special purchases or investments in yourself or business!
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David Fortune has been the editor NoBSIMReviews.com since 2019. He is an expert at writing content on stock advisory services, side hustles, reviewing online business opportunities and many more topics. You can learn more about David on our about us page.