What you need to know. Always check with your accountant/tax counsel because even though you want this to be tax advice, this isn't tax advice.
One of the first concepts I learned while studying economics is a phrase made popular by the economist Milton Friedman: "There is no free lunch". An Econ professor once wrote it on the white board in all caps and it's stuck with me ever since.
Maybe you understand this adage all too well. It applies to so many aspects of life. It certainly applies with a side gig that is actually making money: you can't get something for nothing.
Side gigs, also known by modern nomenclature as side hustles, aren't exactly a new concept. Before "hustles" I think we just called them jobs. The big difference with today's side hustles and the last generation's job juggling is how workers had been employers and are now contractors. For example, a handy man on task rabbit, a driver for Uber and a host for Airbnb are all independent contractors and not employees. It's not limited to new tech platforms. A graphic designer, social media manager and photographer can all be freelance workers too.
The Many Names of Income
The IRS classifies income in different ways. The wages earned as an employee of a company is sometimes also called W-2 income. Self-employment income is often referred to as 1099 income. Shareholder non-dividend distributions can alternatively be called K-1 income. The numbers and letters (W-2, 1099 and K-1) refer to the form that income gets reported on for the tax year. The report is submitted to the IRS. All of this so ultimately the IRS can make sure they get their cut of everyone's income in the form of income taxes.
In almost all instances, an employee will receive W-2 income. Why is it called W-2 income? Because the IRS is not creative; that's why. The W-2 form is the form that an employer must send to an employee and the Internal Revenue Service (IRS) at the end of the year. The W-2 form reports an employee's annual wages and the amount of taxes withheld from his or her paycheck. Which means, as an employee, you're paying income taxes as you go.
When you work as an independent contractor and you earn over a certain threshold ($600 in 2016), the income that you're earning will be classified as 1099-MISC income. There are many different 1099 forms for different types of income. They all serve the same general purpose, which is to provide information to the IRS income from non-employment-related sources. 1099 income does not have any taxes withheld. So if you owe taxes on 1099 income, it's your responsibility to make sure you report it and pay it.
Do I Need to Pay Taxes on Side Hustle Income?
For most people the answer is yes. The reporting requirements per the IRS (at the Federal level) are as follows: For single taxpayers under age 65 with a total income (from all sources) of at least $10,350, all income must be reported to the IRS. For those of you who are married, under 65 and filing jointly, the income threshold is $20,700.
So first look at your total income. If it meets the threshold, then no matter how much side hustle income you've earned, you must report it and pay taxes on it.
For example, if you are 27 years old and you make $36,000 year as an employee at an ad agency and $500 being a nanny as an independent contractor. Yes, you need to pay taxes on the side hustle income.
If you're 35 years old, an employee of Dick's Sporting Goods where you earn $29,000 a year in W-2 income and you earned $5,000 for the year via your organic, locally sourced, artisanal pet rock shop on Etsy. Yes, you need to pay taxes on the side hustle income.
In some instances you will be required to report your income even if you do not receive a Form 1099-MISC. Disclaimer: Make sure to ask a tax professional about your specific situation.
What Happens If I Don't Report My Income?
Well. Teeeeechnically, it's a form of tax fraud. At the Federal level the consequences of the fraud paying a penalty fee.
One type of penalty is the failure-to-pay penalty. This is equal to 0.5 percent of your unpaid taxes for each month, or a portion of a month, after your tax return is due. Another type of penalty is the accuracy-related penalty. This fee is equal to 20 percent of the underpayment if you purposely or substantially understated how much taxes you owed.
Beyond being responsible for paying penalties, you could also owe interest that accrues on the unpaid tax amount. Interest will continue to accrue until it is completely paid off. While it's true that the IRS would likely need to audit you to find your income tax reporting transgressions, at the steep cost, it would definitely behoove you to be honest and accurate from the gate.
Ok. Fine. How Do I Report It?
Step 1: Keep Records Through Bookkeeping
Make sure you're keeping records of all of the income you earn through your side gig and all the expenses your side hustle has paid. I recommend you keep records through bookkeeping and not some crappy Google Sheet. If you're consistent, just like exercising your body or anything you do consistently, the results can be life changing.
Step 2: File Your Taxes
After you have accurate and up-to-date records, use said records when you or your tax professional is filings your taxes. If you're running a sole proprietorship, then you'll most likely report your self-employment income and expenses on the form of your personal tax return called the Schedule C. If you earned income from renting property, it should be reported on the Schedule E.
If you have a partnership, then you'll need to make sure you are filing income accurately, based on each partner's ownership. You most definitely should be working with a legit tax pro to help you navigate this.
How Can I Determine How Much I Owe?
The taxes you owe are a function of how much money you make, the type of income it is and the amount of deductions you can take. So ultimately, you need to look at your entire income situation to figure this out. The more revenue streams you have, the more complicated it can be to try to determine this on your own.
Set Up Bookkeeping and Stay Consistent.
One way to try to stay ahead of the curve is making sure you're keeping timely and accurate records. Thankfully, once again technology is coming in with the win to help us out. Quickbooks Self Employed and Xero Tax Touch are relatively easy to use, low cost apps/programs that can help you stay on top of this.
Honestly, guys. Just imagine back in the day, when people had to use an actual fucking ledger to keep track of all of the sales made and the expenses paid out. Think about pre-calculator days. I'm just bringing this up to give you perspective and to motivate you to take the relatively easy steps to setting up bookkeeping for your side hustle. Take advantage of the tools available to you.
Set Up a Tax Savings Account or Adjust Your Withholdings
Talk to your tax pro about saving a portion of your side hustle income into a tax savings account. Saving between 10-30 percent of your side hustle earnings is a generally acceptable rule of them.
Alternatively, if you have an employer that pays you W-2 wages, you might want to increase your current withholdings. This means, you'll pay more in taxes each pay period which will decrease your take home pay. But the rationale is that you're paying in extra to help keep up with the amount of taxes you might owe from your side hustle. Talk to your tax pro because you may not end up owing any taxes on your side hustle and overwithholding taxes means you're not able to use your money until it comes back to you in the form of a tax return.
Look Into Making Quarterly Tax Payments
Talk to your tax pro about making quarterly tax payments. If they think it's a good idea, they'll help you by preparing vouchers for you. On the voucher, it'll have everything you need in order to make quarterly tax payments: who to write the check to, the amount and the due date. You just follow the voucher instructions.
Quarterly tax payments can help you make smaller payments over the year so you don't get hit with a big tax bill when tax day comes. This is a really great strategy for personality types who might loose sleep not knowing how much they'll owe in taxes.
State and Local Filings and Taxes
There's one more caveat to side hustle earnings: you might also be subject to state and local taxes or filings. I know, I know, it's a lot. You can simply start calling your local small business administration office and asking them what filing requirements you're subjected to. If the sound of that makes you want to throw up on yourself, you should be working with a tax pro, small business attorney or consultant to help you navigate this.
Even though bookkeeping and tax filing are both silly, modern economy kabuki, you're choosing to participate it in. And of course, there is no free lunch.