Millions of Americans have a side hustle in addition to their full-time work. Whether it involves a hobby or dabbling in what may become a full-blown business, side hustles are a great way to earn extra income. In fact, one in three full-time workers have a side gig, and close to half of these side gigs belong to millennials looking for ways to boost their income.
Although side hustles are a great way to fund a vacation, pay off debt or add to disposable income, everyone and anyone involved in a side gig will need to account for and pay taxes on money earned. Avoiding taxes is not an option and will result in fines and penalties in addition to the taxes that are owed. That said, does having a side business help with taxes? That all depends on your situation. Here, we'll look at 10 ways — both positive and negative — in which your taxes will be affected by your side hustle.
10 Ways a Side Hustle Will Impact Your Taxes
Many new business owners ask the following question: Can a side hustle reduce your taxable income? For the most part, the answer is yes. Running your own business comes with benefits that are not available to many other people working full-time jobs. This is a good thing and provides you with tax breaks, credits and deductions that will help lessen your tax burden, effectively putting more money in your pocket or into your business. Here are 10 ways a side gig can impact your taxes.
1. Deducting Expenses Related to the Operation of Your Business
There are a number of tax write-offs that solopreneurs and freelancers can take. One of the biggest write-offs includes your home office. For this to be counted as a legit write-off, your home office needs to be a dedicated workspace for your business and not your couch or recliner. Other write-offs include equipment purchased, such as computers and printers, as well as the supplies needed to run your business — ink cartridges, paper, tools, furniture, etc. You can also deduct a portion of your utilities, as well as your cell phone and internet costs. (Just remember to save all of your receipts and bills!)
2. Contributing to a SEP IRA
Having a side gig also gives you the opportunity to squirrel away more money, saving you from declaring it as taxable income. One way to achieve this and build your nest egg at the same time is by setting up a Simplified Employee Pension (SEP) Retirement Account. According to the IRS, a self-employed individual can contribute 25 percent of their side hustle income into a SEP account, maxing out at $58,000.
3. Qualifying Business Income (QBI) Deduction
This applies to business entities such as an LLC or S Corp and is known as pass-through taxation. The QBI is a deduction that can amount to 20 percent of the side business income. Pass-through means that what you earn in your side gig “passes through” your personal taxes without having you owe corporate business tax. More information on this can be found on the IRS website.
4. Tallying Business Meal Costs and Travel Expenses
You can deduct 50 percent of your meal when it’s directly related to your business. This includes meals with clients, vendors or customers related to your side hustle. You can also deduct 100 percent of your travel expenses. This covers airfare, hotel, taxi, car rental, Uber and any other travel expense related to your business.
Costs associated with professional development can not only help improve your business prospects but also be deducted from your side hustle taxes. This includes signing up for a class or course related to your business, as well as attending conferences and seminars that include registration fees and membership dues. Magazines, books and online subscriptions can also count as deductions associated with your side gig's cost of doing business.
6. Keeping Track of Your Income and Expenses
Track your expenses. And don't forget to save your receipts! Keeping track of where your money is going will help you calculate how much you owe in taxes. One way to do this is by setting up a separate business checking account and credit cards dedicated to your business expenses. Also keep track of your income. Make sure you receive your 1099s and accurately report what you are earning in your side gig. This can be accomplished through bank statements dedicated to your business.
7. Setting Aside Up to 35 Percent of Your Income
Unlike a 9-to-5 job where your employer is responsible for deducting your taxes from your paycheck, having a side gig means that you need to keep track of what is owed to Uncle Sam. Owing money to the government can be scary and costly, and unless you earn less than $600 in your side gig business, you are responsible for paying taxes on a side hustle. Having a side hustle means that you are responsible for your self-employment tax, as well as federal and state tax. This combined bill can be as high as 35 percent but should go down depending on your declared side hustle tax deductions. (Also look into item #9 below: opting for an S Corporation tax election.)
8. Paying Estimated Quarterly Taxes
As a self-employed solopreneur, you will likely need to pay taxes each quarter. This is where your 35 percent saved will come into the picture. Since you do not have an employer withholding taxes from your paycheck, you must do so yourself if you are expected to owe $1,000 or more at tax time and pay it to the government quarterly. You can use tax form 1040-ES to estimate your quarterly payments.
Paying by quarter requires making tax payments on April 15, July 15, September 15 and January 15. These payments can be made directly online.
One way to lower your self-employment tax (including Social Security, Medicare and FICA) is to file as an S Corp. (This also applies if you set up your entity as an LLC that elects to be treated as an S Corp at tax time.) By choosing this option, you pay yourself a salary or draw down on the business. Filing as an S Corp will help reduce the amount of tax you pay on your LLC earnings and will require an S Corporation Tax Election (form 2553).
10. Anticipating a Higher Tax Preparation Bill
While most full-time employees get a W-2 form, things get more complicated when you have a side gig and are set up as a business entity. Your tax returns are longer and you have more forms, including 1099s, Schedule C (business expenses) and other forms depending on your situation. This can add to your tax preparation charges, but at this point, it’s better to let a CPA or professional tax prepare work on your taxes than take on the task yourself. Above all, you’ll want to make sure that your filing is accurate to avoid any unnecessary risk of going through an audit. (Don't forget that fees for preparing your taxes also count as a deduction!)
Setting up Your Business Entity and Partnering with Incfile
Starting a side gig comes with many benefits and responsibilities. It can provide an opportunity to increase income and allow you to do something you enjoy outside of your 9-to-5 job. Who knows? Your side gig might also turn into a successful full-time job! If you are ready to start a side hustle, do it right by setting up a business entity and taking advantage of the tax benefits that come along with incorporation. Incfile has helped over 800,000 small businesses form and grow their business, as well as navigate through tax filings and forms.
Peter Mavrikis is an author and editor with over 25 years of experience in publishing. He has worked as the Editorial Director for Barron’s Educational Series, as well as Kaplan Test Prep, where he ran the test prep, foreign language, and study guide divisions. Peter has also written several books on history, exploration, science, and technology.