There's nothing wrong with trying to earn a little extra cash to pay off debt or get ahead on savings. Last year almost half of Americans were estimated to have a side-hustle. If you don't have a job on the side, chances are you know a few people that do.
While earning a little extra money can be a good thing for your pockets, it has an impact on your taxes, too. When you're ready to file taxes (and we recommend doing so ASAP, despite Tax Day being moved due to coronavirus), follow these tips.
1. You'll get some extra forms
Expect some 1099 forms in the mail or your inbox. A copy goes to you and the IRS. Don't throw these away! You'll need them when you file your taxes to show the income you made from a certain company.
Even if a client hasn't sent you a 1099, you'll still need to report that income on your taxes. Not reporting it on your taxes -- even if it's paid in cash -- is a form of tax fraud.
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2. You'll spend some extra time filing
If you don't have a separate business set up for your side-gig (like an LLC), you're working as a sole proprietorship. While this type of company doesn't have to file business taxes, you do have to complete some extra tax forms.
For instance, most sole proprietorships need to complete a Schedule C form. This is where you report profit and loss from your business. But if your side hustle comes from property rentals, you'll need to complete a Schedule E form. This reports profit and loss from rental real estate, along with other types of partnerships, trusts and estates.
Both forms should be sent in with your personal tax returns.
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3. You could pay self-employment tax
When you work for your day job, you already pay Medicare and Social Security tax. This is something you and your employer split the bill for. But when you work for yourself, you're on the hook for the whole thing.
The self-employment tax rate is 15.3% and that's based on your combined wages and net earnings for the previous year. If your net earnings were $400 or more last year, you're required to pay self-employment tax. For self-employment tax, you'll need to complete a Schedule SE form.
4. You may pay taxes more often
If you work for yourself, you might need to start paying quarterly taxes. This is when you pay taxes on your earnings throughout the year, or "pay-as-you-go." At your day job, taxes are withheld every paycheck. At your side-hustle, you'll need to make estimated tax payments every few months.
If you wait until Tax Day to file taxes for the earnings you make from your side-gig, you could face penalties and might pay interest on the amount you owe.
5. You might qualify for deductions and credits
Running a business means you might enjoy some new deductions on your tax return, including:
- Internet and phone bill: You can deduct part of your bills that are directly related to your business. So if you use 25% of your internet time for work, you'd deduct that on your taxes. If you use your phone a lot, you might want to consider getting a second phone so you can deduct 100% of that cost for your business.
- Home office deduction: You'll need to detail that a space in your home is specifically used for business-related activities. You can also claim related costs to your home office space. For instance, if your home office is 10% of your home, you can also deduct 10% of your annual electricity costs. If you rent office space, you could deduct those costs instead.
- Health insurance premiums: This is an option if you don't have health insurance through your employer and you pay for it out of pocket for your coverage. You could deduct premiums for health, dental and even long-term care.
- Retirement plan contributions: You might already qualify for the Saver's Credit when you make contributions to your IRA. But if you have a business, you could make qualifying contributions to your Solo 401(k), Simple IRA, or SEP-IRA to reduce your tax bill.
How to avoid a huge tax bill from your side-gig
If you don't want to burden yourself with a big tax bill, take a few steps now to limit what you owe.
- Set aside tax money. Self-employed workers should set aside anywhere from 20% to 40% of their income to pay for taxes. So if you earn $1,000 every month from your side-gig, you'd save $200 to $400 of that to go towards your quarterly estimated taxes. If you overpay, usually that excess can go towards your next quarterly payment. The IRS won't know how much you overpaid until you file a tax return in April. But if you overpaid, it'll send you a refund.
- Open a separate business account. If you're running your own business, it's time to treat it like one. Having all your business income go through your business account can save you an exceptional amount of time and hassle come tax time. You'll be able to avoid sorting through bank statements to see what is "business" and what is "personal." It's also a good place to pay for business-related expenses, in case you have any. You may also want to consider incorporating your business so it's completely separate from personal income and expenses.
- Talk to a professional. Taxes aren't simple, especially since rules can change every year. Whether you use software or hire an expert, you don't have to go at it alone. A professional can help you make sure you're doing your taxes the right away without facing penalties. They can help lower your tax bill and possibly increase your return.