How to Avoid Paying Taxes on Side Jobs: A Quick Guide to Save Money
A side hustle is a terrific method to earn extra money to help with financial goals such as paying off loans or saving for a car or home. However, taxes are more difficult for gig economy workers than for full-time employees.
A side job will almost always need the filing of self-employment taxes. This results in a new set of rules and tax forms, as well as several tax questions. It's typical for people who have just begun a side job to be surprised by how much money they owe on their tax statement.
There are tax benefits to side hustle income, and being aware of them can help people minimize their taxable income. For example, there are methods to deduct legitimate company expenditures and even save for retirement with a side job.
Unfortunately, when tax season comes along, independent contractors seldom take advantage of these chances to decrease their income taxes. Let's go through how to avoid paying taxes on side jobs and the considerations you should make.
Penalties for Not Filing Taxes?
People nowadays supplement their income with side hustles such as selling artwork on Etsy or delivering food with Door Dash. Over 69 million Americans have entered the gig economy without paying taxes on their earnings.
Side hustle earnings are considered self-employment and must be reported on your personal income tax return. If an independent contractor fails to declare their self-employment income, they may face the following consequences:
- Charged 5% of unpaid hustle revenue for each month the return is late.
- If you filed your tax return but did not report your gig income on our tax bill, you will face a 0.5 percent penalty for each month you owe (up to 25%).
- If you continue to neglect taxes, the IRS may take action against you, such as forfeiting your refund, seizing your property, charging you, or revoking your passport.
It is not worth the risks to avoid taxes on your side hustle on your tax return.
When Do You Have to Pay Taxes on Your Side Hustle Income?
The IRS defines the gig economy as an "activity where persons make revenue by delivering on-demand labor, services, or items." This covers services such as errand running, online goods sales, and ride-sharing. Basically, if you make additional money through sites like Instacart, Etsy, Uber, and Lyft, you'll have to pay income taxes.
The IRS considers everyone who earns non-W-2 income to be an independent contractor. Even if you have a W-2 job in addition to your side gig, you are still classified as having this employment.
A self-employed person is liable to 15.3% self-employment tax as well as federal income tax. You can reduce your tax burden by making estimated tax payments each quarter.
How Much Money Do You Need to Earn From a Side Hustle to Pay Taxes?
If any of your side hustles make you more than $400, you have to report those gig incomes on your tax return. A corporation or individual that pays you more than $600 should furnish you with a Form 1099-NEC for nonemployee remuneration so that you can complete your tax return.
Payments for revenue received via online payment systems such as PayPal are reported on the 1099-K form. The payer submits these documents to the IRS in order to report federal income taxes.
Self-employment income from payers who issue 1099 forms must be reported by January 31. It should show how much you possessed as well as any tax withholdings that were paid out.
Although it is uncommon, side gig earnings may not be recorded throughout the year. You must record your earnings even if you don't receive a form to complete during tax season.
This is a common scenario for an independent contractor who made less than $600 from a side gig. The payer is not required to provide you with a form, but you will still owe taxes and must file via earnings.
Key Differences of Filing Taxes as Self-Employed
Deductions are automatically deducted from your paycheck when you work a typical W-2 job. This includes Medicare and Social Security taxes. The funds never even get through to your bank account.
When you work for yourself, you take on the obligations of both the employer and the employee. According to tax professionals, this means you should pay anticipated taxes on a quarterly basis.
Your estimated tax is actually pretty simple to handle throughout the year. You can effectively calculate your projected taxes if you keep track of your income and expenses.
You must also file your taxes in April, in addition to these quarterly payments. This is also the time when you'll find out if the estimated taxes you've been paying are sufficient (you may even be entitled to a refund) or if you need to pay extra or face an underpayment fine.
Paying Estimated Taxes on Your Tax Bill
The income tax in the United States is a pay-as-you-earn system. This allows the government to have access to funds throughout the year.
Making incremental payments on your net profits will also help you avoid incurring a large tax bill at the end of the year.
Most self-employed people can utilize Form 1040-ES to make estimated tax payments by April 18th. Use this form to make your quarterly estimated payments (April 15, June 15, September 15, and January 15 of the following year).
If these dates fall on a federal holiday or weekend, your cash payments are due on the next business day for each payment month.
A good thumb rule is to set away 20-35% of your side business earnings for taxes. This ensures that you have enough money to pay your income taxes as well as self-employment taxes.
To manage your taxes more effectively, you can consider opening a separate checking account for your gig income.
Avoid Tax Penalties
Another compelling reason to pay estimated taxes on a quarterly basis. It will really prevent you from owing any more fines.
Over the course of a year, taxpayers are required to pay at least 90% of their total federal income tax burden. If you do not accomplish this goal, you may face further penalties.
The estimated tax penalty might be in the hundreds of dollars. To avoid this penalty, make appropriate estimated payments on your quarterly taxes.
How To Use Tax Deductions To Lower Your Tax Liability
Nobody enjoys having to pay taxes, but failing to do so might land you in a bad situation. Fortunately, there are several methods to lower the amount you may have to pay when it comes to taxes. Business costs might result in the largest tax deduction of any tax-saving strategy.
When you earn money through a side business, the expenses you can deduct must fulfill certain standards. There are regular expenses that your small business may encounter. These are standard operating expenses of your company.
Then there are the small business expenses that are required to keep it running. Ski boots may be deductible as an "ordinary expense" for a freelance ski instructor. The storage area that landscapers hire out to maintain their tools and equipment would be deemed a "necessary expense" for tax deductions.
Having a side gig provides you with an advantage that other self-employed professionals who own their own firms do not have.
Let's go through some of the deductions you might be able to utilize to lower your taxes.
Ordinary and Necessary Expenses
The following conditions must be met for an expense to be considered ordinary and necessary:
Ordinary expenses: Expenses that are normal and reasonable in your line of business
Necessary expenses: Expenses that are beneficial and acceptable for your business; It is not required to be regarded as indispensable in order to qualify as necessary.
This category might include Uber drivers that provide riders with bottles of water and other goods.
Business Expense
Tax professionals will advise you to look for every business expense that you can deduct as a self-employed individual. When you submit your taxes, you can deduct some expenses that W-2 employees cannot deduct.
Pay as a ride-sharing driver is one example of this. When you use your automobile for this sort of service, you should keep track of your miles.
That mileage is deductible on a per-mile basis. Other popular tax-deductible costs for the tax year include:
- Your home's commercial space
- Business-related dues and subscriptions
- Tools and equipment required
- Tuition for vocational education and training
Home Office Deduction
Employees cannot deduct their home office expenses from their net profits. This deduction is not available even if they are obliged to work from home, such as during a pandemic.
You may be eligible if you are self-employed and own your own small business. To be eligible for the home office deduction, you must meet the following requirements:
Use the space solely and on a regular basis: The section of your house or property that is used for business purposes must be used on a regular basis. These places can include an apartment, house, condo, mobile home, boat, garage, workshop, or barn.
Spaces utilized as a bed and breakfast, inn, or in a related hospitality business do not qualify.
The key location for your company activity: Your home office must be your primary place of work. It might also be where you meet with customers on a regular basis. The only exceptions would be if you own a storage business or daycare.
Keeping Solid Records For Your Tax Return
If you intend to claim deductions when you submit your taxes, you must keep meticulous records. The IRS examines an independent contractor's taxes more rigorously than others.
This is due to the fact that the 1040s filed by these workers are not verified by third-party tax statements. Keep all of your tax receipts in case you get audited.
Keeping a second credit card for business expenses is also a smart idea.
Consider Retirement Savings
You don't need a certified financial advisor to inform you that your social security or savings account will not be enough to finance your retirement. Social security now barely meets the basic needs of retirees.
Leveraging your side income for retirement is one of the smartest financial moves you can make. This also minimizes the taxes you will have to pay today.
The solo 401(k) and SEP IRA are two of the best financial products for side hustlers.
Solo 401(k)
Each year, you can contribute up to $57,000 to a solo 401(k). You can contribute up to 100% of your net self-employment income to this fund.
Setting up a Solo 401(k) requires more paperwork than a SEP IRA. The contribution limit is set per individual. This implies that if you have an employer's 401(k) or other retirement plans, your contributions may count against the cap.
SEP IRA
You can contribute up to 25% of your net self-employment income to a simplified employee pension individual retirement account.
The Bottom Line
As a small company owner, you can lower your taxable income and keep more of your money working for you with careful planning. Remember to consult a tax expert to ensure you qualify for the potential savings outlined here.