We all know the expression, “Don’t quit your day job.” But for many of us, side hustles offer that necessary financial breathing room to plan for the future.
What many people don’t realize is that even a few extra bucks a week can come with a price tag at tax time. But fear not! Armed with the right tools, your side-gig might even save you money when you file.
How does a side hustle affect your taxes?
Leave it to Uncle Sam to spoil a good thing. Even if you only earned a few hundred bucks from your gig work, you still have to pay tax on it.
Any income you earn outside of your day job is referred to as “self-employment income.” That’s shorthand for: you’re a business owner.
That might sound overkill for something like Lyft driving on nights and weekends. But as far as the IRS is concerned, you’re a sole proprietor for tax purposes, running a small business all by yourself.
What a sole proprietorship means for your taxes
There’s a lot of bad guidance out there for self-employed individuals, so let’s cut to the chase:
- ✘ No, you don’t need to register for an LLC
- ✘ No, you don’t need to file for a business EIN number
- ✘ And no, you don’t need to open a business checking account
Here’s the skinny: as a sole proprietor, you can earn business income and claim business deductions without formally starting a business.
When it comes time to file, all you have to do is attach Form Schedule C to your individual 1040 tax return. The Schedule C reports your 1099 income. From there, you can calculate your self-employment taxes using Schedule SE. (More on this later.)
When should you start a business for your side hustle?
It only makes sense to consider formalizing your side gig if:
- ✓ It begins to make real money
- ✓ You plan to keep it going for several years
Even then, it’s not a requirement for your taxes. It’s mainly to make the process of doing business easier.
How a formal business name can streamline your side hustle
If your freelance photography business , for example, takes off and becomes your bread and butter, you’ll most likely want a formal business name. You can:
- Handle state filings with it
- Send invoices under it
- Register for business bank and credit card accounts under it
A business name adds legitimacy to your work and advertises what your business is about.
Why starting a business isn't required
You can operate under your personal name and Social Security number while doing business. As far as the IRS is concerned, just be sure to report all your earnings on your Schedule C.
However, there might be some state and local governments that require you to register a business name, so always check the requirements for operating a business in your state.
How to deal with self-employment taxes on your side gig
While there are many upsides to being self-employed, there’s one huge downside: self-employment taxes.
These are a combination of Social Security and Medicare taxes, and they have a combined tax rate of 15.3%. To learn more about how they work, check out our intro to self-employment taxes.
They’re only calculated on your net business income, not your total income for the year. So if you have W-2 income of $30,000 and business income (after expenses) of $10,000, only the $10,000 will be subject to self-employment tax. In this example, that amounts to $1,530 ($10,000 X 0.153).
Unlike income tax, which can be reduced through tax adjustments and individual deductions, the only thing that can reduce self-employment taxes are business write-offs and tax credits. So don’t be surprised if you owe slightly more than usual after you start your side hustle.
Tips for dealing with side income
Not keen on a higher tax bill? I’m right there with you.
Let’s look at some tips and tricks to minimize your self-employment taxes, so you aren’t caught off guard come April.
Tip #1: Know what you can write off
Self-employment taxes are assessed on your net business income. That’s your gross income minus expenses.
That means the best way to lower taxes on your side hustle is to lower your business income.
How does one do that? Great question.
The answer is business write-offs. A business write-off is just another way of saying your work-related expenses. Common examples include things like:
If you’re able to pull together enough write-offs, you might not owe any SE tax at all. (And if you have so many that you generate a loss, it might even lower your regular income taxes.)
Tip #2: Skip the business bank account
When it comes to claiming write-offs, many resources say you need a business checking account. This isn’t true. What you are required to do is keep business records, which is much easier to do with separate accounts.
For side hustlers and gig workers, using your personal accounts might make more sense.
As long as you have a system for tracking your work expenses during the year, you aren’t breaking any laws by buying work-related things using your personal account.
In fact, this challenge is what inspired Keeper’s app in the first place. Gig workers and side hustlers need tools to track their write-offs without easily and efficiently.
Tip #3: Set aside 20-30% of your earnings for taxes
Woof, right? I hated writing that as much as you hated reading it. Unfortunately, 20-30% is the most realistic estimate of how much to save. Here’s why.
Most taxpayers working side gigs fall into federal income tax brackets with effective rates ranging from 12-22%. (Your effective tax rate is your average tax rate.) Add the 15.3% from self-employment taxes on top of that, and the safest approach is to assume 30% of your income will evaporate into thin air.
That might not actually be the case if you maximize your tax write-offs. Still, it’s always better to be conservative when it comes to taxes. If you overpay, you’ll get it back as a refund, but if you underpay, you could be subject to underpayment penalties and interest.
Tip #4: Make payments as you go
We have a pay-as-you-go tax system. What does that mean? It means that your tax technically isn’t due April 15th, it’s due at the time it’s earned.
For your W-2 income, this part is easy. Your employer will withhold taxes on the money you earn from your day job, so you don’t have to worry about it at the end of the tax season.
When it comes to your moonlighting, though, paying as you go, can complicate matters. Without an employer handling taxes on that income for you, you’re left to fend for yourself.
This isn’t just bad news for you, it’s bad news for the IRS too. They want your – err – their money as soon as possible. Consequently, they’ve designed a very easy system to help you pay up on time:
Making estimated tax payments
Due every three months, estimated tax payments are a great way for freelancers and side hustlers to stay on top of things. You can use Keeper’s quarterly tax calculator for an easy projection of how much to pay on the extra money. If cash-flow is tight, just pay as much as you can. It’s better to make a small payment by the due date than to play catch-up on the whole amount next quarter. Don’t want the headache of making estimated payments?
Depending on your situation, you might have another option: using your W-2 job to pay as you go:
Adjusting your W-2 withholding
Believe it or not, you can ask your employer to increase your W-2 withholding to cover the taxes on your side income. All you need is an idea of how much you want to set aside for taxes. Just tell your employer how much extra you want them to withhold for the month — or for the quarter. Alternatively, you can complete a new Form W-4, which lets you report additional income to adjust your withholding calculation.
Tip #5: Get familiar with your Schedule C
I mentioned this earlier, but Schedule C is how you’ll report your side income. I recommend every freelancer at least look at their Schedule C once, even if they hire someone else to prepare it.
This form is where you’ll report your income, business write-offs, mileage deduction, and home office deduction. It’s also the form you’ll need to produce if you ever apply for a bank loan or need to verify income to other creditors.
If you’re a DIY kind of person, check out our step-by-step guide to filling out your Schedule C.
Whether you’re driving for Lyft, freelancing as a web designer, or building your TikTok follower base, with Keeper on your side, you might be able to quit your day job after all!
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At Keeper, we’re on a mission to help people overcome the complexity of taxes. That sometimes leads us to generalize in our educational content. Please email email@example.com if you have questions.