Understanding Side Hustle Taxation: A Guide for Entrepreneurs
With the rise of the gig economy, many people are turning to side hustles to supplement their income. Whether it’s freelancing, online sales, or providing services, side hustles have become an essential part of modern work life. However, one aspect that often gets overlooked is the tax implications associated with earning money from a side hustle. This blog will walk you through how side hustle taxation operates, what to remember, and how to make sure you remain compliant with tax regulations.
1. What is a Side Hustle?
A side hustle is a business or job that you perform along with your primary source of income. It may have many different forms, including:
- Freelance writing, graphic design, or web development.
- Selling handmade items or dropshipping items online.
- Providing services such as tutoring, dog-walking, or driving for a rideshare.
Income from a side hustle is typically treated as self-employment income, which has different tax implications than regular employment.
2. Taxable Side Hustle Income
All income from your side hustle is taxable, whether you work full-time or part-time.
Side hustle income, whether in cash or digital payments, must be reported to the IRS if it reaches a specific amount.
Self-employment income must be reported on Schedule C of your tax return.
The reporting threshold for side hustle income is usually $400 in net earnings, at which time you’ll be required to file a tax return, even if you owe no taxes.
3. Categorizing Your Side Hustle Income
Self-Employment Income: In case you are making money through your side job, the IRS deems it as self-employment income and therefore treats you as a business owner for taxation purposes.
Income Types:
- Freelance/Contract Work: If you have freelance or contract work (i.e., writing, graphic design), you can expect to get a 1099-NEC form from clients who have paid you more than $600 in a given year.
- Online Sales: If you sell products online on sites such as Etsy, eBay, or Amazon, you are required to report sales income even if you do not receive a 1099 form.
- Rideshare/Delivery Driving: For drivers with companies such as Uber or Lyft, income is reported, and you will receive a 1099-K or 1099-NEC depending on earnings.
4. Side Hustle Deductions
One of the benefits of a side hustle is that you can deduct some business expenses to lower your taxable income. Some deductible expenses are:
- Home office expenses: If you work from home, you can deduct part of your rent or mortgage, utilities, internet, and other related costs.
- Supplies and materials: Anything bought for the side hustle, like office supplies, tools, or inventory, can be deductible.
- Mileage and transportation: If you utilize your own vehicle for business travel, you can deduct actual vehicle expenses or mileage.
- Advertising: Expenses of advertising your product or service, such as social media advertising, website fees, and business cards.
- Professional services: Charges for legal, accounting, or other professional services associated with your side hustle.
5. Self-Employment Tax
Aside from income tax, you will also be liable for the self-employment tax (SE tax) on your side income. This is the tax on your Social Security and Medicare contributions.
The rate of the self-employment tax is 15.3% (12.4% for Social Security and 2.9% for Medicare).
You pay the self-employment tax only on the amount of your income that is above $400.
You can possibly deduct the employer’s share of self-employment tax (50%) from your taxable income, which reduces the income tax payable.
6. Quarterly Estimated Tax Payments
Being self-employed, you are required to pay taxes during the year in the form of estimated quarterly payments.
Self-employed persons are required by the IRS to make tax payments four times a year—generally in April, June, September, and January.
If you don’t pay sufficient estimated taxes during the year, you may be subject to penalties when you file your year-end return.
You’ll want to put aside some of your side hustle earnings each month to pay for these taxes so you’re not faced with a big bill when tax time arrives.
7. Side Hustle Record-Keeping
Good record-keeping is necessary so that you report accurate income and deductions on your taxes.
- Keep records of income: Record all earnings and payments, including invoices, receipts, and contracts.
- Store receipts for business expenses: Track and save receipts for business expenditures, like services or supplies, that you expect to deduct.
- Utilize accounting software: Make use of accounting software such as QuickBooks, FreshBooks, or Xero to streamline record-keeping and keep your finances in order.
- Keep digital records: Store digital transactions, receipts, and business documents in a safe cloud storage platform for easy retrieval.
8. Tax Forms You’ll Need
Being a side hustler, you might face an array of tax forms depending on how you earn income:
- Form 1040: The primary form to file your individual income tax return.
- Schedule C: To report self-employment income and expenses.
- Schedule SE: To compute and report self-employment tax.
- Form 1099-NEC: From clients paying you more than $600 for independent contractor or freelance work.
- Form 1099-K: From payment companies such as PayPal, Venmo, or from apps such as Uber and Lyft.
9. Tax Filing
Tax filing for your side business can seem intimidating, but it is part of running a small business. The bright side is that there are some steps you can take to make it easier:
- Use tax software: Sites such as TurboTax, H&R Block, and TaxSlayer offer instructions for freelancers and side hustlers on how to file their taxes appropriately.
- Consult a tax professional: If your side hustle income is complicated or you’re not sure about deductions, then you should consult a tax professional who can assist you with the process and make sure you’re abiding by the tax laws.
10. Common Mistakes to Avoid
- Underreporting income: Failing to report all your side hustle income can result in penalties, interest, and even an audit by the IRS.
- Not keeping track of expenses: Missing out on deductible expenses means paying more taxes than necessary. Keep all receipts and invoices.
- Ignoring self-employment tax: Many people focus only on income tax and forget about the self-employment tax, which can be significant if not accounted for.
- Missing deadlines: Make sure to meet quarterly estimated tax payment deadlines to avoid penalties.
11. Conclusion
Side hustle taxation can be complicated, but with the right tools and knowledge, it becomes much easier to navigate. The key is understanding your responsibilities, keeping organized records, paying estimated taxes, and taking advantage of business deductions. By keeping your taxes in check, you will not only remain in good standing with the IRS but also optimize your income and prevent surprise tax liabilities. Whether you’re just beginning or have been working hard for years, side hustle taxation know-how is key to creating a thriving and lasting side business.