5 Tips to Prepare Your Side Hustle for Tax Time

We acknowledge and recognize you, as a hard-working individual. We are aware of your efforts in juggling multiple jobs to make ends meet. We appreciate your dedication using your skills to edit photos videos etcetera at odd hours. Your commitment to your work is inspiring.

Perhaps you’ve taken up one or even two side hustles to accelerate your debt repayment, or maybe you simply enjoy utilizing your free time to bake cookies or design websites. Regardless of the reason, the notion of earning extra income is appealing to anyone.

However, it’s important to be cautious because your side hustle earnings can potentially lead to tax-related complications when the tax season arrives. All it takes is one significant job or a few new clients to significantly increase your tax liability. Here are three ways in which your side gig could disrupt your taxes:

• Depending on the extent of your efforts throughout the past year, your tax bill may surge by hundreds or even thousands of dollars.
• If your side hustle prospers to a certain extent, you might be required to pay estimated taxes regularly throughout the year. Failing to meet these payments on time can result in penalties imposed by the Internal Revenue Service (IRS).
• What if the Internal Revenue Service (IRS) demands proof that you genuinely spent $1,000 on cooking supplies as a business expense? Do you possess the necessary receipts or bank statements to substantiate your claim?

This may seem overwhelming, but it’s crucial to be prepared for all of these possibilities. Here are some measures you can take to prevent your side hustle from adversely affecting your taxes:

1. Allocate 20-35% of your side hustle income for taxes

Just as your regular job withholds income taxes from your paycheck, it’s essential to recognize that your side gig income lacks such withholding. Therefore, it is your responsibility to report and pay taxes on your side hustle income. To avoid surprises during the tax season, create a separate savings account and set aside 20-35% of your side hustle earnings for income taxes and self-employment taxes.

2. Determine if you need to pay estimated taxes

Our tax system operates on a “pay-as-you-go” basis, meaning the IRS expects individuals to make regular tax payments throughout the year instead of a lump sum. If your side gig brings in a few hundred dollars annually, you may not have to worry about estimated taxes. Simply keep track of your earnings, file your tax return as usual in the spring, and pay the resulting tax liability. Generally, you are required to pay estimated taxes if you anticipate owing more than $1,000 in taxes when filing your tax return. To fulfill this obligation, you have two options:

1. Divide the expected tax into four equal payments and pay them when due
2. Adjust your tax withholding at your primary job using a new W-4 form to account for the taxes owed on your side hustle income. Consulting a tax advisor can help you determine if estimated taxes are necessary.

3. Establish a separate checking account for side hustle expenses

It’s time to treat your side gig as a business because that’s precisely what it is. Similar to any small business, you can deduct certain side hustle expenses from your taxable income, effectively reducing your tax bill. 

However, identifying business expenses from personal ones on your bank statements can be challenging. To simplify the process, open a checking account exclusively for side hustle expenses. This will facilitate the identification and calculation of your side gig expenses throughout the year.

4. Create a straightforward record-keeping system

Choosing a record-keeping system that suits your preferences is important. Whether you prefer the old-school method of labeled folders or the convenience of a digital system, make sure it allows you to organize and access your receipts and documents easily. 

Why is this relevant to taxes? Firstly, having all your side hustle-related receipts in one accessible place will help you accurately determine the amount you can claim as business-related deductions, instead of guessing. Secondly, if the IRS ever requests verification of your expenses, having a paper trail will provide the necessary evidence.

Here are a few essential documents and information to include in your record-keeping system

• Receipts
• Bank statements
• Business records
• Tax forms
• Car mileage and car expenses

5. Seek assistance from a tax professional

By now, you’ve probably realized that having a side hustle can complicate your taxes beyond what you’re accustomed to. Trying to navigate all the tax intricacies associated with it can be overwhelming. That’s why we recommend working with a reliable tax advisor who can provide guidance and expertise. This way, you can ensure your taxes are done correctly and focus more on doing what you love. 

Remember, taking proactive measures to handle your side hustle income and taxes will save you from potential pitfalls and unexpected tax burdens. By setting aside a portion of your earnings for taxes, determining if estimated taxes are necessary, maintaining separate accounts, organizing your records, and seeking professional advice, you’ll be better equipped to manage your side hustle’s impact on your taxes.