Managing Your Business
Side Hustle Taxes: What You Need to Know and Common Deductions
The additional income you can make from a successful side hustle business is a welcome boost to your budget. With side gig earnings, you may be able to enjoy those extras that you couldn’t afford otherwise.
But a side hustle is still a business, and as a business owner, you oversee every aspect of running a company, including tax payments. Understanding your responsibilities regarding your side hustle taxes will help ensure that your gig remains financially successful. Fail to plan for the taxes on your side hustle, and you may end up scrambling to scrape together a tax payment.
Who Needs to Pay Side Hustle Taxes?
You may be thinking, “I just have a small side hustle business that brings in some extra cash. Do I really need to pay taxes on what I make?”
The answer is probably yes. According to IRS rules, you must pay taxes on your side hustle if you have net earnings of $400 or more in a calendar year. If you have reached this amount in earnings for the year working your side gig — or will soon — it’s time to start tax planning.
The IRS defines gig work as any activity that earns you income. Such employment may be done through an app or website, or it could involve individual clients and customers. Side hustles include driving, deliveries, renting out property, running errands, performing handyman services, tutoring, consulting, providing creative and professional services, and selling goods online.
Generally, the companies or platforms you work through for your side hustle will send you a 1099-K or 1099-MISC by the end of January with a total of your earnings for the prior year. If you work for more than one entity, you will get multiple forms. You submit these tax forms along with your tax return.
Steps to Handling Taxes on a Side Hustle
Many first-time side gig business owners find the topic of taxes intimidating and confusing. That’s why we’ve put together this comprehensive step-by-step side hustle taxes guide. Follow these steps, and you’ll be ready when it’s time to pay Uncle Sam.
1. Track Your Income and Expenses
You can only make informed tax decisions if you have accurate information about how much you’re earning with your side gig and how much running the business costs. While the income you bring in is important, what you spend on your side hustle is equally essential. Expenses are side hustle tax deductions that can lower your tax liability and save you money on taxes.
It’s vital to record every penny you earn (and spend) running your side hustle. This includes payments via credit cards, checks, cash, bank and wire transfers, and payment platforms like Venmo, Zelle, and PayPal.
There are many methods for tracking income and expenses. You could try the “old school” way on paper or use one of the many digital programs designed for bookkeeping. There are free programs like Google Sheets and paid platforms like Fresh Books, QuickBooks, and TurboTax Self-Employed.
How you track expenses isn’t as important as doing so consistently. The key to tracking income and expenses is to choose a system that is easy for you to use. Otherwise, you’ll likely put off the process and get behind on your bookkeeping tasks. Procrastination ends up causing you undue stress at tax time and can even result in late tax returns and penalties.
Try to keep all your tax documents in one place, whether in a digital, cloud-based organization system or papers in a regular old filing cabinet. Information you’ll want to keep for record-keeping purposes includes receipts, bank statements, credit card statements, tax forms, car mileage and expenses, and business records, including articles of incorporation.
2. Understand Side Hustle Banking Basics
With some business structures, such as sole proprietorships, you can use your personal checking and savings accounts for your business transactions. Others, like LLCs, require a business banking account.
However, even if using your personal checking and savings is an option, getting separate business accounts has several significant advantages for the side hustler. If you are working as a sole proprietor, you will need to form a “Doing Business As” (DBA) company before you can open a business bank account.
Getting a business banking account legitimizes your side gig. If you are ever audited by the IRS, having separate accounts proves that you’re operating your business professionally.
Side hustle banking accounts also streamline operations, saving you time you can better spend running and developing your business. Rather than spending hours wading through combined personal and business expenses to get accurate earnings information, you can simply use the data from your business bank accounts.
Many online accounting systems are set up so you can upload your banking data to the appropriate expense categories. By having an account dedicated to your business, you can quickly see how much money is going in and coming out of your side hustle each month. Open a business checking account for expenses and earnings, and have a business savings account to pay taxes and other significant expenses.
Before opening a business account, you’ll need an Employer Identification Number (EIN). Also referred to as a Federal Tax ID, this nine-digit number acts as a social security number for your business. To take credit and debit card transactions from customers or apply for a business credit card, you must have a business bank account.
3. Know Your Side Hustle Taxes
If you’re a successful side hustler, you’ll quickly discover that small business income taxes are more complex than your typical employee 1040. Here are the main taxes you will pay as a small business owner.
At most jobs, the employer oversees employee payroll and paychecks. But when you have a side hustle, you are both employee and employer. This means the IRS expects you to pay both the employer half of Social Security taxes and the employee half. The self-employment tax amounts to 15.30% of your profits. Of this, 12.40% goes toward Social Security, and the remaining 2.90% pays to Medicare.
Federal income tax
As you do when working for an employer, you must also pay a portion of your income to the IRS in the form of federal income tax.
State income tax
If your state has an income tax, you are responsible for paying any state and local taxes on your side hustle. Tax liability for state income tax varies widely. To find out what your state charges, check your state revenue or taxation website.
4. Set Aside Money for Taxes
Given the not insignificant taxes you pay to run a legit side hustle, it’s a good idea to save money throughout the year so you’ll be ready come tax time.
If you are unsure how much you’ll need, saving 20%-35% of your side gig earnings is a good ballpark figure to ensure you have enough or nearly enough to pay Uncle Sam. After a couple of years in business, you should have a better idea of a more accurate percentage. If you save more than you need, you can use the surplus to get a head start on next year’s tax savings.
Do I Need to Make Quarterly Tax Payments?
To help ensure small business taxpayers don’t end up with massive tax debt they can’t pay, the federal government requires business owners making over a certain amount of money to make estimated tax payments every quarter of the year.
The due dates for estimated taxes are April 15, June 15, September 15, and January 15 of the following year. The money you pay for estimated taxes goes toward the next year’s taxes due.
If you pay enough in estimated taxes throughout the year, you may owe very little or no taxes come tax day. If you overpay quarterly taxes, you’ll get the excess back as a refund, but it’s best to pay as close to what you think you’ll owe as possible. There’s no sense in letting the government hold on to money that you could better invest in your business.
However, if you don’t pay enough in estimated tax, you could be charged a penalty. You may also be penalized if your estimated tax payment is late, even if you are due a refund. It’s a bit of a balancing act. But as the name suggests, estimated taxes are not exact, just what you expect to owe in taxes for the current calendar year based on how much revenue you realistically expect to make.
The point at which you must begin making quarterly tax payments depends on how much money your side gig earns. According to the IRS, sole proprietors, partners, and S corporation shareholders usually must make estimated tax payments beginning when they expect to owe at least $1,000 in taxes for the year. The threshold for corporations is lower at owed tax of $500 or more.
To pay estimated taxes, you’ll need IRS Form 1040 ES, which also has instructions for calculating your quarterly payments. You start by determining the total gross income you expect to earn this year then subtracting your expected deductions. Consult the IRS Tax Rate Schedule on the form to see how much you owe.
If figuring out estimated taxes is confusing or you want to ensure you’re doing it right, it may be helpful to consult a certified public accountant or tax advisor.
What if I Work in Multiple States?
If you work in multiple states, you may wonder if you must pay taxes in each. As a self-employed gig worker, you pay income taxes to the state where you live and work, even if clients reside elsewhere. But if you commute to another state for work, you may need to file income taxes in more than one state.
Side Hustle Tax Deductions
The good news about running your side hustle business is that you can write off many business expenses on your taxes. This is a perk that an employee working for a company doesn’t typically have.
A write-off is an expense that reduces taxable income. It’s in your best interest to ensure that you report every possible write-off on your tax return. Missing eligible deductions on your tax return can end up costing you substantial tax savings.
According to the IRS, eligible tax deductions must be “ordinary and necessary” and commonly accepted within your industry. Necessary refers to expenses needed for you to run your business effectively. The expense doesn’t need to be indispensable; it just needs to be something that would normally be used to run a business in your industry.
For example, if you’re a virtual assistant, you will likely need a computer, telephone, and internet service to operate effectively. You can write off part or all those expenses. If you’re a rideshare driver, you can write off auto expenses, including maintenance, service fees, vehicle insurance, and a mileage deduction. But in either case, trying to claim a new Xbox as a deduction on your taxes probably won't fly.
Potential Deductions for Your Side Gig
The list of potential deductions for your side hustle is long. When determining deductions for your business, look for expenses necessary to run your side hustle successfully.
Keep a detailed record of all your expenses, including saving original receipts and invoices in digital or paper form. Have the receipts on hand in case you need to prove what you’ve spent to run your business.
Common Side Hustle Tax Write Offs
Here are some of the more common deductions you can write off on your taxes:
- Advertising and marketing expenses
- Bank fees
- Business insurance
- Contract labor fees
- Interest for business loans or credit cards
- Dues for industry organizations
- Computer equipment and software
- Education expenses for continuing study in your field
- Health insurance premiums
- Industry and professional licenses
- Industry publications
- Internet and phone
- Office expenses
- Rental fees
- Retirement plan contributions
- Startup costs
- Supplies and materials
- Meals and travel for business purposes
- Materials and supplies
Home Office Deduction
You can also deduct home office space, although the IRS dictates strict rules about what qualifies. The deduction applies whether you own or rent your home. You must use the home office regularly and exclusively for conducting your business.
If you have an extra room in your home or a studio or garage that you only use for your side gig, you are eligible for the home office deduction. But if you also use the space as a guest room, it is not eligible. An office in your kitchen, bedroom, or living room is also not acceptable.
The home office must be your principal place of doing business. Let’s say you rent an office somewhere that isn’t your home. If you do most of your work in that external office, you can’t claim the home office deduction. But you might still be able to claim it if you rent an office space elsewhere but still do a lot of work from home in a dedicated workspace.
The home office deduction is based on the percentage of your home dedicated to business use. There are two options for calculating the deduction. The simplest method is deducting $5 per square foot of space with a maximum of 300 square feet, which amounts to a $1,500 deduction.
The more involved method of figuring out the home office deduction starts with determining what percentage of your home’s overall square footage is used for the office. Then calculate how much you spent on operating costs, such as utility bills, mortgage interest, home repairs, homeowner’s insurance, WiFi, and similar expenses. You can claim 10% of those costs as a home office business expense.
The miles you drive for your side hustle may also be tax-deductible. This is another deduction that requires some calculation. To get the correct numbers, you must keep accurate records of the dates that you drive, the mileage, and the purpose of those trips.
There are two ways to determine your mileage deduction. The first way is the easiest — simply use the IRS-determined standard mileage rate. The other way is to calculate your auto expenses based on the operational costs of your car, such as gas, oil changes, repairs, and car insurance.
Retirement Account Contributions Are Tax-Deductible
A great way to earn deductions for your side hustle and save money for the future is to open a retirement account designed for entrepreneurs. These include a Simplified Employee Pension Plan (SEP-IRA) and a One-Participant 401(k), also known as a Solo 401(k).
Both types of retirement accounts allow you to make a yearly contribution of up to 25% of your side hustle income pretax, which lowers your overall taxable income. Keep in mind that you will be taxed when you withdraw from the retirement accounts at a later date.
Filing Self-Employment Forms
When you file your income taxes as a side hustler, you need to fill out some extra forms. This means that filing taxes will be a bit more complicated than it used to be.
You’ll need Form 1040, Schedule C, Schedule SE, and Form 8829. The latter form is used to make a home office deduction. To file quarterly estimated taxes, you’ll need Form 1040-ES.
Consider Hiring a Tax Professional
If the idea of doing your own side hustle taxes intimidates and confuses you, you might want to seek the assistance of a certified public accountant (CPA) or a licensed tax professional.
Getting expert tax help would be an especially good idea if your side hustle is pulling in a substantial amount of money. Filling out tax forms can be time-consuming, especially if you aren’t familiar with the process. That’s time you could spend working on your business.
You could also make a mistake that could lead to a costly tax penalty. Without the proper experience, you may also miss deductions that could have saved you money. It’s possible that by getting the assistance of a tax professional you save more money than if you did your taxes on your own.
To find a reliable, competent tax professional in your area, check out the IRS Directory of Federal Tax Return Preparers with Credentials and Select Qualifications.
If you’re thinking about starting a side hustle or are already running one and don’t yet have your federal tax number, now is a good time to get your tax ID.
Swyft Filings provides expert EIN/Tax Number services. The process is quick and easy. Our experienced professionals will do the work of obtaining your EIN for you so you can get back to doing what you do best — running your successful side hustle.