When it comes to stretching your budget, working a side hustle or part-time gig is an effective way to ensure you’re earning enough to cover your expenses. But here’s the rub: Your side business carries repercussions for your taxes.
“People who have been doing side gigs usually owe [taxes] and are surprised and shocked that they owe,” says Nayo Carter-Gray, an enrolled agent at 1st Step Accounting in Baltimore. Freelancers should prepare for the very real tax results of essentially running a side business, she says. “I tell my gig workers to consider themselves mini-franchise owners,” Carter-Gray says.
If you’re accustomed to punching in as a traditional employee, you may need to start thinking like a self-employed small business owner, depending on your side hustle, experts say. For example, workers for the ride-hailing services Uber and Lyft or errand-running site TaskRabbit are considered independent contractors. That means taxes are not automatically withheld from their paychecks, and they’ll need to pay income tax and self-employment tax each year while tracking and deducting qualified business expenses and potentially making quarterly tax payments. Failing to do so could land those gig workers with an unexpectedly high year-end tax bill.
If you’re dabbling in the world of side hustles, here’s what to know about the tax-filing consequences so they don’t catch you off guard.
[See: Answers to 7 Burning Tax Questions.]
Budget for what you’ll owe the IRS. When you work as a traditional employee, your boss handles income-reporting and tax-withholding for you. This typically reduces what you owe at tax time (if you owe anything at all) since taxes are withheld from your paycheck. Because it’s all taken care of, you don’t usually have to worry about logging your income independently or paying quarterly taxes.
The situation is not as simple when you’re selling your skills through a side hustle. If you’re working as an independent contractor, freelancer or self-employed part-time business owner, you’ll be responsible for tracking and reporting the money coming in and potentially paying taxes each quarter and in the right amounts.
One important step to note: Estimated tax payments are required throughout the year if you owe $1,000 or more on your federal tax return, says Phyllis Jo Kubey, enrolled agent and certified financial planner in New York City. These payments can be made online through the Electronic Federal Tax Payment System or IRS website and app, she says. You’ll also want to check your state’s requirements for paying estimated taxes. “For freelancers, especially with erratic cash flow, paying taxes quarterly can be difficult. They don’t always have the funds needed on the quarterly payment dates,” she says. “The good news is that you can make your estimated tax payments at any time.”
[See: 7 Most-Missed Tax Deductions and Credits.]
Keep an eye out for a 1099 form. If you receive at least $600 as an independent worker, you might receive a 1099-K or 1099-MISC form that logs what you’ve received in income. You’ll use that to fill out the Schedule C form detailing the income earned in your side hustle. But even if you don’t receive a 1099 form, you’re responsible for tracking your earnings and expenses, reporting them and paying the appropriate taxes on them. “This is why it is so important for someone starting a side gig to begin keeping good records of their income themselves,” Kubey says.
If you rented your home through a site such as Airbnb for fewer than 15 days last year, you won’t report your income or claim deductions for that income. If you rented it out for 15 days or more, you’ll need to keep tabs on earnings and deductions and report that information using a Schedule C or Schedule E form.
Track qualified business expenses. One way to reduce the taxes you owe as a side hustler or freelancer is to track and deduct qualified business expenses. For an ride-hailing app driver, these expenses might include mileage, car insurance, depreciation on your automobile and bottles of water for your riders. Someone who runs an Etsy shop might deduct their home office or studio space and shipping or postage costs.
There are myriad software programs, mobile applications and organizational systems for tracking and documenting expenses. Intuit’s QuickBooks is one. Expensify is another. MileIQ is an app that tracks mileage. Find what works for your particular hustle and use it consistently, experts say.
One good habit to adopt: Use a separate bank account, credit card and debit card for all transactions related to your side hustle, says Chris Hardy, enrolled agent and managing director at Paramount Tax and Accounting. “It’s a big hassle if someone doesn’t have those funds segregated out,” he says. Even if you need to use your side hustle money for a personal expense — an extra debt payment, for example — take money from that separate fund to pay yourself.
[Read: Know How and Where to Store Your Tax Documents.]
Understand that this will impact your personal taxes. Keep in mind that not only will you potentially have a higher tax bill and a more complex tax-filing process as a side hustler, but this will impact your personal tax situation as well. If you earn enough, you might lose access to the earned income tax credit or the student loan interest deduction, Carter-Gray says.
Plus, students or parents who have a child headed to college in the near future might find that the extra earnings impact their eligibility for need-based financial aid or eliminate eligibility for the federal work-study program or Pell Grant. Keep those trade-offs in mind as you go forward.
Consider bringing on a professional. If all this sounds too complicated to handle as an individual, consider hiring a tax professional, such as an enrolled agent, to help you navigate new tax territory. An enrolled agent is the highest status the IRS awards, and these tax professionals are allowed to represent you before the IRS and must commit to ethical standards and continuing education requirements.
A qualified tax pro can help you track which expenses you can write off and when and how to make quarterly payments. He or she can help you keep an eye out for reasonable deductions and relevant new tax legislation. For example, the new tax reform law, which goes into effect for 2018 taxes, includes a 20 percent pass-through deduction for self-employment or business income that passes to an individual from an entity such as an S corporation or partnership. If you need help interpreting something like that, a visit with a pro might be in order.
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The Tax Consequences of Your Side Hustle originally appeared on usnews.com
