28 Apr 15 Common Side Hustle Tax Mistakes to Avoid
It may be too late to avoid side hustle tax mistakes when filing 2020 taxes, but there is still time to prepare so you don’t make the same side hustle tax mistakes in 2021.
Note: The IRS has extended the federal income tax filing due date for individuals from April 15, 2021, to May 17, 2021. Additionally, victims of the Texas winter storms that began February 11, 2021, now have a tax filing extension until June 15, 2021.
According to a data report by Zapier, “One in three Americans—34 percent—have a side hustle.”
And that percentage is expected to grow.
Zapier further claims, “61.1 million Americans (24 percent) plan to start a side hustle in 2021.”
Whether you are just now discovering the joy of earning additional income by working a side hustle or hope to begin one in 2021, taxes can come as a shock.
A large number of those blogging, selling on Etsy, or grocery shopping for others are often unaware of the ins and outs of taxes for their new side venture.
As a result, they make some (or all) of the following costly side hustle tax mistakes. Don’t let it happen to you.
#1 Not Reporting All Your Side Hustle Income
One of the common side hustle tax mistakes is not believing you owe taxes for the money you make “on the side.”
This is incorrect. According to the IRS, “You have to file an income tax return if your net earnings from self-employment were $400 or more.”
If your side hustle brings in at least $400 in 2021, you are legally required to file an income tax return.
According to Yahoo Finance, “Nearly half of Americans have side hustles: working as Uber or Lyft drivers, picking up gigs through TaskRabbit or getting additional freelance work. […] The average worker with a side gig brings in an extra $1,122 a month by working 12 hours a week.”
In other words, most American side hustlers should be filing tax returns.
Unfortunately, when it comes to side hustle tax mistakes, this one goes beyond simply not filing.
Many side hustlers fail to report all of their income (i.e., neglect to tell the IRS about some of the income made).
CNBC claims, “Gig economy workers have good reason to be wary of the taxman. Independent contractors are among the taxpayers most at risk of failing to accurately report their income at filing time.”
As a result, these side hustlers receive a CP2000 notice, which means “the income and/or payment information we [the IRS] have on file doesn’t match the information you reported on your tax return.”
#2 Not Treating Your Side Hustle as a Business
Another one of the common side hustle tax mistakes newbies make is not treating their side hustle as a business.
It is a business, and as such, there are certain steps you should take to protect yourself come tax time.
As a beginning side hustler, you likely filed your 2020 tax return as a sole proprietor.
But should your side hustle expand, it may be beneficial to create an LLC (limited liability company).
As an LLC, you will have more tax advantages. With an LLC, you can choose between being listed as a sole proprietor or as an S Corp.
If you meet the IRS criteria to be a limited liability company S Corp, you are considered both the business owner and an employee.
As a result, you pay fewer taxes because, instead of paying both self-employment taxes and income taxes on profit, you only pay self-employment taxes on your employee salary and income taxes on any additional business profit.
Contact an attorney to see which business structure is right for your situation.
#3 Not Paying Quarterly Estimated Taxes
If you owe more than $1,000 in taxes and didn’t make quarterly payments, you have fallen victim to another of the side hustle tax mistakes – and you’ll get penalized.
Side hustlers (who will owe more than $1,000 in taxes) generally have to file quarterly taxes rather than filing once a year.
However, it is important to file your quarterly taxes the right way, or else you risk being penalized for underestimating what you owe.
The Wall Street Journal reports, “A growing number of people who pay taxes quarterly are getting their payments wrong and incurring penalties as a result. […] According to Internal Revenue Service data, the number of filers penalized for underpaying estimated taxes rose nearly 40% […] to 10 million from 7.2 million.”
When you first pay quarterly estimated taxes, it is worthwhile to contact a professional accountant. They can walk you through the steps and teach you how to set it up so it will be easy to do each quarter.
#4 Not Taking Deductions
One of the common side hustle mistakes is failing to take deductions.
You are entitled to claim deductions for business-related expenses, such as office supplies, internet service, and car expenses.
[Related Read: Beginner’s Guide to Side Hustle Taxes]
#5 Taking Too Many Deductions
On the opposite end of the spectrum, other gig workers get themselves in trouble for taking too many deductions.
On the popular show Schitt’s Creek, one of the main characters misinterprets deductions and spends lavishly on new bedding, face cream, and more believing he can write these things off.
His father exclaims, “That is not a write-off. This is not a write-off. You can’t just buy things for yourself and write them off.”
While it is a funny scene, it is one of the common side hustle tax mistakes people make.
It is important to avoid abusing deductions. For example, while you may be allowed to write off the cost of fuel for your Uber shift, you can’t write off fuel mileage for personal travel.
#6 Not Prorating Expenses
Speaking of the difference between fuel mileage for your Uber shift and personal travel, you should prorate your expenses.
Services like Uber keep track of your mileage, which makes this easy to prorate.
It doesn’t stop with your vehicle. You can also prorate internet usage, as well as a percentage of your home’s annual electricity costs if you have a home office.
Some people miss out on these types of deductions because they don’t know they can prorate expenses. They mistakenly think that if they can’t deduct everything, then they can’t deduct anything.
Don’t miss out! Consider all the expenses you use to make your side hustle work and prorate as necessary.
#7 Not Keeping Good Records
Many side hustlers find themselves struggling at tax time because they fail to keep good records.
For example, if you want to claim deductions, you need to have records (such as receipts).
Side hustlers must keep track of their expenses for their own protection should they face an audit of their tax returns.
#8 Not Contributing to a Retirement Plan
A side hustle tax mistake people tend to make is not knowing they can contribute to a SEP-IRA, a Simple IRA, or a Solo 401(k), which will reduce your tax bill and allow you to put more into retirement than you’d typically be allowed.
A traditional IRA has a $6,000 contribution for the year. In comparison, a SEP IRA has a significantly higher contribution limit – up to $58,000 or 25% of your self-employment income.
Let’s say you earn $30,000 from your side hustle. You can contribute $7,500 to a SEP IRA.
#9 Not Using Business Finance Tools
Once again, treat your side hustle as a business.
Instead of stashing receipts in a shoebox or keeping Post-It notes with client payment information, invest in tools for keeping track of business finances.
#10 Not Sending 1099s to People You Paid
Many side hustlers work with other side hustlers, but one of the most common side hustle tax mistakes is neglecting to tell the IRS about it.
Let’s say you hire someone to create a logo and other graphic designs for promotional materials for your side hustle. If you paid that graphic designer more than $600 in 2020, you should have sent him a 1099 form.
The due date for sending 1099s is usually January 31. Should you fail to do so, you can face fines from the IRS.
#11 Not Seeking Professional Help
You’re a side hustler, so you are used to doing things on your own.
But, when it comes to filing your taxes, this is one time when you really should consider paying for professional help.
A professional accountant can help you avoid these side hustle tax mistakes (ultimately, saving you money by avoiding fines and penalties).
#12 Not Deducting Accounting Costs
Not only will working with a professional accountant protect you and likely save you money in the long run, but you can also deduct accounting costs.
While individuals are no longer allowed to deduct the cost of tax preparation and accounting services, businesses are still allowed to claim these as deductions.
#13 Not Separating Business and Personal Accounts
If you want to make filing taxes easier and avoid common side hustle tax mistakes, then open a separate checking account for your business.
This will make it much easier to keep personal and business expenses separate.
Plus, it will simplify paying quarterly estimated taxes because you can print out a quarterly finance report from your business account.
#14 Not Calculating Taxes Monthly
Don’t make the mistake of forgetting about taxes when looking at your monthly income.
It’s fun to see your money grow – but a good chunk of that money will go to Uncle Sam.
Instead, estimate how much you will owe in taxes each month based on what you earned.
#15 Not Saving for Taxes
Once you calculate how much you will owe in taxes each month, go ahead and start putting this money aside.
Save this money for your taxes, so it won’t hurt as much when it is time to pay the IRS.
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