29 Jul Beginner’s Guide to Side Hustle Taxes
Let’s talk paying taxes on your side hustle.
Whether you’ve jumped into the gig economy to pick up some extra cash or did so with a plan to grow a successful side business, if you don’t plan for taxes, you are in for a big shock come tax season.
Keep reading to learn the ins and outs of paying side hustle taxes, as well as the different tax advantages for side hustles.
Yes, You Will Have to Pay Side Hustle Taxes
If you made more than $600 in a calendar year from a company, you need to pay taxes on the income earned.
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.”
This means most side hustlers are earning more than $600 a year, which means they owe Uncle Sam.
With that in mind, you should anticipate paying taxes on your side hustle.
The reason that comes as a surprise for many newbies is that they are used to their employer taking taxes out of their paychecks.
Since you work for yourself in your side gig, you are now the person responsible for paying those taxes.
That’s why April can be a big surprise for those new to the side hustle biz.
If you haven’t been preparing to pay taxes on your side hustle, you’ll likely be surprised by how much you owe the IRS.
Lindsay Van Thoen explains for Freelancers Union, “You owe taxes on the profit of your business – your total income minus your expenses. But the total percentage depends on how much income you make overall, of course. Expect 20-30% as a rough estimate.”
This will seem like a huge hit if you haven’t prepared for it.
Paying Quarterly Taxes on Your Side Hustle
Another surprise for many side hustlers is having to pay quarterly taxes.
If you owe more than $1,000 in taxes, you are required to file and pay quarterly estimates instead of filing taxes once a year.
The College Investor suggests, “A simple rule of thumb for determining your quarterly tax payments is to take your projected annual income and multiply it by 30%.”
Many side hustlers find they actually like quarterly tax payments because they don’t feel “as big” as a large lump sum come tax time in April.
Christy Bieber for The Motley Fool explains, “If you don’t make quarterly estimated tax payments and you owe the IRS a lot of money at the end of the year, you’ll be subject to penalties based on underpayment.”
Treat Your Side Hustle like a Business
If you want to get the most out of your side hustle, then you need to treat it like a business.
When you shift your mindset from bringing in extra cash to running it like a business, you will generate more income and have a better idea of your tax implications…and can plan accordingly.
Planning may include looking for write-off opportunities and making decisions on certain purchases based on what you can deduct.
Business owners use software to track expenses, keep records, and maintain finances, and they use a business credit card for business expenses.
Often, beginner side hustlers don’t view themselves as running a business, but they absolutely are.
When you act like a business owner, taxes will be easier, and you’re less likely to have sticker shock come tax time!
Choose the Best Business Structure for Side Hustle Taxes
As a side hustler, you need to choose the best business structure for your business.
If you are just starting, you are most likely considered a sole proprietor.
This means you have started making money on the side that you claim on your personal tax returns, but you are not a legal entity.
For example, let’s say you start walking dogs as a side hustle.
Once you go over $600, you are required to pay taxes on this income and are considered a sole proprietor.
Now, let’s say your dog walking business has picked up a steady clientele. You may want to create an LLC (limited liability company).
As an LLC, you are personally protected against business liabilities.
It also gives you 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.
This means you pay less taxes because you only pay self-employment taxes off your employee salary and then income taxes on the additional business profit (rather than both self-employment and income taxes on profit).
Deduct Expenses to Pay Less Side Hustle Taxes
If you are treating your side hustle like a business, then you are entitled to claim deductions for business-related expenses.
This gets a lot of beginners excited, but it doesn’t mean you can claim deductions for anything and everything.
However, there are plenty of business expenses you can claim to reduce your taxable income.
Basically, you can claim deductions that relate to your business.
For example, if you have an Etsy shop where you sell artisanal homemade goods, then you can deduct the cost of supplies.
Here are some common side hustle deductions:
- Your home office or co-working space – You can claim your home office, if and only if, the space is solely dedicated to your business.
- Your website – If you pay a yearly or monthly fee to maintain your website, you can deduct this expense.
- Your telephone and internet expenses – If you use your telephone or internet for your business, you can deduct these expenses.
- Office supplies – Office supplies purchased for your business, including computers and printers, can count as deductions. Additionally, computer software used for your business, such as accounting software, can be deducted.
- Advertising – Whether you advertise on Facebook or send out flyers, advertising costs can count as deductions.
- Meals – You can deduct 50% of a meal if it is for entertaining clients.
- Car expenses – With vehicle expenses, you can either make a deduction based on your own totals or use the IRS’s standard mileage rate.
I cannot stress how important it is to track and document everything that you hope to claim as a deduction.
Save every receipt, track your usage and mileage, and keep good records.
[Related Read: 7 Best Budgeting Apps for Side Hustlers]
Ask Your Side Hustle Company About Possible Write-Offs
As a part of the sharing economy, there are several companies that provide individuals with side hustle opportunities, such as Uber, Shipt, and Instacart.
These companies do not withhold taxes for you, so you are required to do the hard tax work yourself.
However, these companies typically offer helpful tax information like the types of deductions you can make, such as mileage while driving for Uber or parking fees you pay as a grocery delivery driver.
Prorate Expenses as Needed
Unfortunately, you can’t claim your entire internet bill or all the gas for your vehicle as a deduction.
But you can prorate expenses for deductions.
You can’t deduct anything deemed personal use, but you can claim prorated deductions for expenses incurred using personal goods (such as your personal vehicle).
So, if you use the internet personally, you can only claim the portion of internet usage related to your business.
Likewise, if you drive for Uber or Lyft, you can’t claim all of your vehicle expenses as deductions, but you can claim a mileage deduction. Services like Uber keep track of your mileage, which makes this easy to prorate.
Additionally, if you do have a home office, you can deduct a percentage of your home’s annual electricity costs.
Contribute to a Retirement Plan
With self-employment income, you can take advantage of different retirement accounts beyond the tax-advantaged 401(k) and IRA accounts.
By contributing to a SEP-IRA, a Simple IRA, or a Solo 401(k), you can reduce your tax bill and put more into retirement than you’d typically be allowed.
According to Finance Buzz, “For a SEP plan, you can contribute as much as 25% of your earnings, or up to $57,000 in 2020. For a 401(k) plan, you can contribute that amount plus annual salary deferrals of up to $19,500 and an additional $6,500 if you’re 50 or older.”
Since the money contributed is pre-tax, you aren’t responsible for paying taxes on it until you withdraw it.
Open a Separate Checking Account
The more you side hustle, the harder it will be to keep track of your business-related expenses and transactions.
That’s why it is wise to open a separate checking account just for your side hustle business.
This will make it so much easier to keep your personal expenses separate when it comes time to file your side hustle taxes.
Rather than having to sort personal and business expenses on your bank statements, with a separate business checking account, all you have to do is print out a financial report quarterly to file quarterly estimates.
Plus, if you do choose an LLC, it makes you look like a more legitimate business.
Take Advantage of Software and Apps for Recordkeeping
Along these same lines, it is critical to invest in software and apps for tracking your business finances.
You have to keep good records for taxes – especially in the event you are audited.
Instead of keeping a box full of paper receipts, download apps that allow you to snap pictures of receipts and store them in a virtual receipt bank.
Additionally, there are apps that help you track your mileage, such as Stride.
Calculate Side Hustle Taxes and Save Monthly
The best rule for side hustle beginners – calculate side hustle taxes and save monthly.
It’s easy to see your side hustle money grow without thinking about what you will owe the IRS.
But this is a mistake. Don’t let April sneak up on you and surprise you.
Instead, estimate how much you think you will owe in taxes each month (aim for between 20%-30%).
Then, take that amount of money and set it aside.
If you save for taxes out of the side hustle income you bring in each month, you will not be shocked when it is time to pay taxes.
Speak with a Professional
Finally, there is a learning curve when it comes to paying taxes on a side hustle.
Rather than incorrectly file your taxes and face penalties, it is wise to speak with a professional accountant in your first year.
They’ll help you find any deductions you missed and identify other ways you can pay less in taxes. What you pay the accountant will be worth the savings on your taxes.
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