If you took on a side hustle last year to make ends meet and earn some extra cash, you may have found an unexpected surprise when you filed your taxes. If you did not prepare carefully, you probably ended up with a big tax bill for your troubles, possibly with penalties and interest added on.
Given the unpleasant surprises of the past, you may be resigned to a life of higher taxes, all courtesy of the very side hustle you thought would help you gain financial freedom. But before you put away your driving gloves and give up on ride sharing and grocery delivery, you might want to take a second look at your situation.
With the right planning and preparation, your side hustle could actually lower your tax bill, giving you an even bigger reason to keep driving, door dashing and doing whatever it takes to make ends meet. Here are some key ways to make your side hustle pay-off come tax time.
Note: If you fall behind on filing your taxes or owe back taxes to the IRS, you’re not alone and we can help. Reach out to our tax resolution firm and we’ll help you file late tax returns and negotiate with the IRS if you owe back taxes.
Start By Estimating What You Expect to Earn
It can be difficult to estimate how much you might earn from your side hustle, especially if the time you devote to it and the amount you make varies week to week. Even so, it is important to estimate your income, not only to plan for your deductions but to make advance tax payments as well.
If you expect to earn more than $1,000 from your side hustle, you should strongly consider making quarterly tax payments to the IRS. If you fail to pay ahead, you could end up with a tax penalty when you file, and possibly interest and other charges as well. If you end up overpaying what you owe, you will receive a refund when you file your taxes.
You can start estimating your earnings by looking at how much you made last year. To fine tune the figure even more, you can look at your monthly earnings to date and annualize that figure to determine how much you could earn for the entire year.
Consider a Health Savings Account
If you have a health savings account, either through your employer or purchased on your own, you may be eligible for a health savings account, and opening one could significantly reduce your taxable income, so you can keep more of your side hustle money.
In addition to the tax savings, a health savings account can help you pay for medical expenses, both expected ones and costs that would otherwise have drained your emergency fund. Since the money you put into an HSA if fully tax deductible, this simple step can lower your tax bill quite a bit.
Open a Self-Employed Retirement Plan
If you have a side hustle, even on a part time basis, you are considered self-employed, and that means you can open a retirement plan designed for self-employed individuals. The type of account you can open, and the amount you can contribute, will be dictated by the type of business structure and your earnings, but many of these retirement plans are quite generous in their contribution limits.
If your side hustle is truly a sideline and you have a full-time job with a traditional 401(k) plan, you may be eligible for a SEP-IRA, a unique form of account designed specifically for small business owners and the self-employed. If your side hustle has gone full time, you may want to look at a solo 401(k), a retirement plan that offers high contribution limits and an enormous potential for tax savings. You will need to apply for an employer identification number (EIN) to open this type of 401(k), but you can get that number free from the IRS.
Take Advantage of Your Deductions
Having a side hustle gives you a chance to tax advantage of certain deductions, and using those deductions could significantly reduce your taxable income and boost the size of your refund.
If you run a business out of your home, for instance, you may be eligible for the home office deduction, and that will entitle you to write off part of your mortgage, utilities and other costs. You can also take a standard home office deduction based on the square footage of your dedicated workspace and the size of your home.
In addition to those deductions, you may be able to write off things like office supplies, the cost of internet access and phone service and automotive expenses if you use your car as part of your side hustle or full time business. You should always check with a tax expert before claiming these deductions, as every individual situation is unique.
Side hustles are becoming more common, and that is good news for many wallets. But when tax time rolls around, those partially self-employed individuals will need to do some serious planning to keep their bills in check, including following the steps outlined above.
Life as a freelancer or gig worker can be wonderful, but it’s not uncommon to see self-employed taxpayers land in trouble with the IRS and owing back taxes.
If you do run into tax trouble, reach out to our tax resolution firm and we’ll schedule a free, no-obligation confidential consultation to explain your options in full to permanently resolve your tax problem.