When it comes to taxes, what freelancers don’t know can hurt them. So, if you’ve got income from a side hustle, now’s the time to do a crash course on side gigs and taxes.
Why do I need to know about side gigs and taxes?
People who only have wages from an employer don’t need to know a lot about taxes. That’s because their employers deduct tax withholding from their wages, so they rarely need to worry about a big tax bill in April. Moreover, employees get precious few work deductions. So, filing an annual return is fairly simple and risk-free for the average employee.
But things change dramatically the moment you engage in a side hustle. That’s because there’s no employer to handle your income tax obligations — nor the little-understood “employment tax.” Moreover, where employees get few deductions, side hustlers can claim many.
So, while you have more obligations, you may also have more opportunities. That means doing your taxes poorly can cost you real money.
Nuts and bolts
To clarify the tax rules for side hustlers, we’ve turned to Philip J. Holthouse, chairman of Holthouse, Carlin & VanTrigt, the nation’s 31st largest independent accounting firm.
Can we start with why so many people who freelance/side hustle end up with a surprise tax bill?
The main reason is most side hustlers are treated as “independent contractors” rather than employees. So there is often no federal or state income tax withheld from their payments, like there is from employee wages.
Additionally, few people are great at keeping a running tally of how much they’re earning and spending on a side hustle. So when they add it all up at the end of the year, it can be a surprise. And, where it might be great to see that you earned more than you expected, it also means you’re likely to owe more tax than you expected.
How much do I have to earn before I owe taxes on my side hustle income?
If you make more than $14,600 ($21,200 for married couples) from your main job, you are required to file a tax return. And you should report all side hustle income, no matter how small the amount.
If your side hustle is your only income and you are self-employed and/or classified as an independent contractor, you should file a tax return if your net income from the side hustle is $400 or more
Why do I need to file a return with just $400 in income when it’s a side hustle?
While you won’t owe income taxes at that level, you could owe “employment taxes.”
What are employment taxes? And why are they a bigger issue for people with freelance income?
Employment taxes and self-employment taxes are assessments for Social Security and Medicare. People with modest earnings pay more employment taxes than income taxes because employment taxes apply to the first dollar of wages and to self-employment income once it is above $400.
Workers and employers generally split this obligation, with the employer paying half and the worker paying the other half. But when you’re self-employed, you are both the employer and the wage-earner. Thus you pay both sides of this tax.
Is there something people with side gigs ought to be doing to reduce the chance of a bad surprise at tax time?
Three tips:
- Keep track of how much income you make during the year.
- Keep track of all your related expenses so you can offset the deductible ones against your income. Your goal is to pay tax on your net profit — your income minus your expenses — not your total income.
- If 1 minus 2 is adding up to thousands of dollars, you should make quarterly estimated tax payments during the year so that you do not have to pay it all in April when you file your return and so you do not get nicked with penalties for failing to make estimated tax payments.
What about deductions? Do people with side hustles have more deductions than employees?
Absolutely. It is difficult for employees to get much tax benefit for out-of-pocket expenses related to their jobs.
Self-employed side hustlers can typically deduct most or all of their expenses related to their side hustle. Deductible expenses could include: travel, business meals, computers/monitors, supplies, internet/data charges, subscriptions, and home office expenses.
What about travel and entertainment expenses?
After the 2017 tax law changes, most entertainment expenses are no longer deductible. But business meals can be deductible, subject to some limitations and subject to extensive documentation requirements. Business travel expenses, including a per mile allowance for using your own car, are generally deductible. But expenses for commuting to your regular workplace are generally not deductible.
Are health insurance expenses deductible for side hustlers?
Yes, possibly including contributions to health savings accounts.
What about home offices?
Yep, if a portion of your home or apartment is used regularly and exclusively for your side hustle.
Is taking the home office deduction worth it? I’ve heard it often isn’t worth much and can be an audit trigger.
If you’re a renter, it’s absolutely worth taking. If you have a dedicated home office, that takes up, say, 20% of your home or apartment, you can write off 20% of your rent as your home office expense.
For homeowners, the deduction can be tricky. But there’s a “safe harbor” that can make it simple if you use 300 square feet of your home or less. This allows you to simply deduct $5 per square foot used exclusively as a home office.
If your office is bigger than that, you might want to consult a tax advisor to determine whether the deduction is worth the cost of claiming it.
What if, after accounting for all of your costs, you have a loss from your side gig?
You can generally deduct that loss against other income you may have like wages or investment income. If you have no other income, you may be able to carry the tax loss forward to offset taxable income in the future.
Can you use that loss to reduce your employment income?
Generally yes, a net loss from a side hustle can offset your taxable wages as long as you are active in the side hustle. However, it will not offset the employment taxes you pay on your wage income.
What about retirement plans?
If you made a profit from your side hustle, you are probably eligible to make contributions to tax-friendly retirement plans. Consider exploring IRAs, Roth IRAs, Solo 401(k) plans and SEP IRAs.
Any other tax issues for side hustles?
Of course. If you have employees in your side hustle, you will need to file payroll tax returns and send tax withholdings to the government. If you make payments to other self-employed individuals in the course of your side hustle, you may need to file 1099 forms. And depending on where you live and do business, you may have state taxes to manage as well. The more successful your side hustle, the more complex the tax issues become.
