Millions of Americans have come to appreciate the value of having a side hustle that brings in a little extra income each year.
But there’s one drawback to a successful side gig: It adds a new level of complexity to your income taxes.
Whatever your primary source of income may be, if you have a side gig, you likely qualify as self-employed in the eyes of the IRS.
That means you’ll have to jump through a few extra hoops to report your side income and correctly calculate, and pay, the resulting taxes.
Anyone with self-employed income is required to fill out Schedule C when preparing a federal tax return. If you have $5,000 or less of business-related expenses to report, you can use the Schedule C-EZ instead. A side hustle resulting in a loss for the year requires you to use Schedule C rather than Schedule C-EZ.
If your side job involves work as a contractor for a single company, then calculating your self-employment income will be quite simple. Assuming the company pays you at least $600 per year, it will send you a Form 1099-MISC reporting the amount of income you were paid. It’s a good idea to double-check this number against your own records to make sure it’s accurate. Once you’ve confirmed that the Form 1099-MISC is correct, you can simply transfer this figure to your Schedule C on the “gross receipts or sales” line.
If you have multiple clients or customers, you’ll need to add up your 1099-MISC figures and other sales figures for the year in order to calculate your total gross receipts. Side gigs that involve selling physical items allow you to mark the cost of buying, maintaining, and transporting inventory in the “cost of goods sold” section under Part III of the Schedule C. The total cost of goods sold is then subtracted from gross receipts to determine the gross income from your side job.
Pretty much any expense related to your side gig is fair game for the expenses section of the Schedule C. For example, if you used a credit card to buy supplies for your business and had to pay interest on the credit card charges, you can list this interest as a business expense on line 16b. Make business calls on your phone, and you’ll be able to subtract a percentage of your phone bill as a business expense (you’ll have to figure out how much of your phone usage was personal to know what percentage of the bill you can count as a business expense).
Similarly, if you use your car to do some business-related driving, you can claim a business expense for those miles. The easiest way to do so is to use the standard mileage rate, which means simply adding up the number of miles you drove for business purposes, multiplying by the IRS-provided business mileage rate, and noting the result on your Schedule C.
It’s extremely important to keep records of all your business expenses in case of an IRS audit. Bills, receipts, and other documentation should be kept for at least five years. You can keep these records as physical documents, digital copies, or both.
Quarterly estimated taxes
If you’re going to owe $1,000 or more for the year to the IRS, you’re supposed to prepay your federal taxes quarterly. This $1,000 limit doesn’t include taxes that are withheld by your primary employer; it’s only the taxes you would pay along with your tax return for the year.
Calculating your estimated taxes can be tricky, especially during the first year, when you don’t have any information from previous years to reference. However, it’s possible to use the estimated tax “safe harbor” approach to guarantee you won’t get hit with an underpayment penalty, even if you do underestimate your quarterly tax payments.
By the time you’re done going through all this tax-related hassle, you may be wondering if that side gig is worth the trouble. But consider this: If you made so much money through your side gig that you ended up owing $1,000 or more in taxes, you’re doing pretty darn well. For example, if you’re in the 25% tax bracket, owing $1,000 in taxes on your side gig income means that you made at least $4,000 from said gig that year. That’s not exactly chump change — so having to spend a little extra time on tax preparation is well worth it.
— Wendy Connick
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Source: The Motley Fool