Credit Karma Guide to Filing Taxes for Your Side Hustle
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Millions of Americans work side jobs to supplement their salaries. If you’re one of them, you’ll need to pay taxes on the earnings from your side hustle. Here’s how to meet IRS expectations when it comes to your side jobs.
When you have a salaried job, your employer handles a lot of tax tasks for you, including withholding your Social Security and Medicare taxes. You are also provided with a W-2 form that has information you need to file your income tax return.
But when you have a side hustle, no one does those things for you. You’re responsible for making sure you meet all your tax responsibilities, whether your side hustle supplements your salary or is more of a “main hustle” and your primary source of income.
Working a side hustle means you’re now both boss and employee, with all the freedom self-employment offers, but also with the added tax duties.
Working for yourself goes by many names. You’re side hustling. You’re part of the sharing or gig economy. You’re a freelancer or a sole proprietor.
The Internal Revenue Service has a name for this, too. You’re self-employed.
Being fully self-employed generally offers you much more freedom than being a 9-to-5 cubicle worker.
However, regardless of whether your side hustle is in addition to a salaried job or you’ve patched together a variety of gigs to make a full-time living, being self-employed also demands more attention to, and responsibility for, taxes.
What is an independent contractor?
Whether you’re a ride-sharing driver with Lyft or Uber, a home-repair specialist connecting with clients through TaskRabbit, or a landlord temporarily renting your home (or a part of it) to vacationers via Airbnb, you are your own boss.
You’re in good company within more-traditional jobs. Many doctors, dentists, lawyers and accountants also tend to be self-employed. But a job description or title doesn’t determine your self-employment status. The main factor is how much control you have over how you do the work.
The IRS says it generally considers someone a self-employed independent contractor if the person who pays the contractor for doing the work can only control or direct the result of the work, and not what the contractor will do or how they will do it. This can sometimes be a sticky issue, especially if a client has some particular demands.
Such concerns have caused problems for Uber and some of its drivers, who have claimed that the ride-sharing company treats them like employees, not contractors, and have taken their arguments to various courts.
Even in more-traditional work situations, employee or contractor misclassification is an issue that the IRS keeps a close eye on — correctly identifying workers makes a big difference for both company and individual tax bills. When the IRS discovers an employee misclassification, it steps in, which could mean added taxes for the employer.
Generally, you can rely on IRS guidelines to determine whether you are a contractor or an employee via three key factors: how much control a boss has over how the work is done, finances related to the job, and the parties’ perceptions of the relationship.
3 key factors to determine whether you’re an employee or a contractor
1. Behavioral control
The IRS says you are an employee if the business you work for has the right to direct and control how you perform your work. This is true even if the company doesn’t exercise its right to control, such as instructing you, training you and evaluating your work. For example, if the company provides more-detailed instructions on when and where to work, that may signal that you are really an employee and not an independent contractor.
2. Financial control
If the business has the right to direct or control the financial and business aspects of your job, then you are typically an employee. For example, if a business has made a significant investment to buy equipment that you use for your work, or reimburses you for expenses you incur to produce the product or service they’re paying for, then you could be considered an employee, rather than an independent contractor. Contractors generally provide their own material, pay for needed (and potentially tax-deductible) supplies to complete the job, and are more likely to incur unreimbursed expenses. Plus, independent contractors generally can seek other business opportunities.
3. Relationship matters
When it comes to determining employment status, the thought really can count. The IRS says that how you and the business perceive your relationship can indicate what type of relationship it actually is — employee or contractor. Things that affect such perceptions include written contracts (which usually spell out a contractor arrangement), employee-type benefits provided (which typically are provided only to employees), the permanency of the work relationship (contractors typically are short-term or per job), and how integral the work is to regular company business.
What’s taxable in the sharing economy?
Based on what the IRS has to say about it, you’ve decided you’re an independent contractor. So how much of your income from your side hustle is taxable?
The short IRS answer is “all of it.” This includes both cash payments as well as in-kind income such as barter arrangements.
That’s right. The dental work you got in exchange for giving your orthodontist rides to and from her office is taxable too. The IRS says that the value of products or services from bartering is normally taxable income.
Bartering has been around since the first caveman decided his neighbor had something he needed or wanted, and it existed as a form of payment long before currency. In its simplest form, bartering is the trading of one product or service for another.
Bartering may be done on an informal one-on-one basis between individuals and businesses, or it can take place through a third party, typically a barter exchange company. When done via an exchange, be sure to provide the barter broker with your taxpayer identification number (TIN) or Social Security Number. If you don’t, the broker must withhold backup tax amounts on the bartered values and report them on 1099-B forms issued to the contractor and copied to the IRS.
Regardless of the method used to barter a contractor’s services or products, the IRS considers the service or product received as taxable payment. You’ll need to report the fair market value of the barter as income on your tax return for the year in which you received the barter income.
All income counts
Some independent contractors mistakenly believe they only have to pay taxes on their side hustle income if it exceeds $600. This confusion usually is based on the IRS requirement that a payer need only report what it paid an independent contractor if the amount is $600 or more, via Form 1099-MISC. This tax statement goes to the person who was paid, that is, the independent contractor, as well as to the IRS, which uses this third-party documentation to double check taxpayers’ annual Form 1040 filings. However, even if you got just $100 from a client, that $100 is taxable — despite the payer not being required to report the amount.
The fact of the matter is that you are generally required to pay income tax. According to the IRS, you have to file an income tax return if your net earnings from self-employment were $400 or more. And even if your net earnings were less than $400, you may still have to file a return if you meet other filing requirements.
What are your self-employment tax obligations?
In addition to reporting your taxable independent contractor earnings to the IRS for income tax purposes, you also must pay self-employment, or SE, taxes. These are the self-employed equivalent of traditional federal payroll taxes: the Social Security and Medicare taxes an employer would withhold from your paycheck.
When you earn a salary, you and your employer equally share these taxes, which together are part of the Federal Insurance Contributions Act. That’s 6.2 percent for Social Security (on earnings up to the annual Social Security wage base) and 1.45 percent for Medicare, bringing the total of these taxes to 15.3 percent: 7.65 percent paid by the worker, 7.65 percent paid by the boss.
Side hustling doubles self-employed tax duties
As both a self-employed boss and worker, you must calculate the full 15.3 percent in FICA taxes due on your independent earnings. However, once you figure the full amount of self-employment tax you owe and include it on your return, you can deduct one-half of that SE tax amount on your Form 1040.
The amount of self-employment income that triggers self-employment tax obligations is $400 or more. You report and pay SE tax on Schedule SE. You may also have to pay SE tax if you had church employee income of $108.28 or more.
Paying estimated taxes
U.S. income tax is a pay-as-you-earn system, ensuring that the government has the money it needs to operate throughout the year. For taxpayers, incremental payment of taxes throughout the year prevents a huge year-end tax bill.
As a self-employed individual, you generally need to make your tax payments by filing estimated taxes using Form 1040-ES by April 18 (in addition to filing your annual Form 1040), as well as by June 15, Sept. 15 and the following year’s Jan. 16 (though, you don’t have to make this January 16th payment if you file your 2017 tax return and pay the entire balance due by January 31, 2018). As with annual tax filing, if the estimated deadline is on a weekend or federal holiday, it’s due the next business day.
5 ways to pay estimated taxes
You have several choices for how to pay your estimated taxes. They include:
1. Writing a check or sending a money order by mail, payable to U.S. Treasury, not the Internal Revenue Service. You’ll need to include an estimated tax payment voucher.
2. Paying online at IRS.gov/payments by:
- IRS Direct Pay directly from your checking or savings account.
- Charging your tax bill to a credit or debit card. This is done through one of the IRS-approved card payment processors: WorldPay Inc., Official Payments and Link2Gov Corporation. Note that the processing companies charge a convenience fee.
- Electronic Fund Withdrawal (EFW), again by paying directly from a financial account.
- IRS2Go, the IRS’s mobile device app.
- Online Payment Agreement if you cannot afford to pay your tax bill in full by your tax return due date.
3. A phone call to one of the three service providers, who will accept a debit or credit card payment on behalf of the IRS:
- WorldPay Inc. 1-844-729-8298
- Official Payments 1-888-872-9829
- Link2Gov Corporation 1-888-729-1040
4. Using the Electronic Federal Tax Payment System. You must enroll in EFTPS before you can use it to pay not only estimated taxes but many other tax liabilities, both personal and business.
5. Paying in cash, limited to a single transaction per day of $1,000. You can pay this way through retail partners, but first you must register online at OfficialPayments.com/fed, which manages the cash tax payments.
Pay or prepare to pay penalties
In addition to keeping the IRS happy, paying estimated taxes four times a year will keep self-employed individuals from owing the U.S. Treasury even more in penalties. The IRS wants taxpayers to pay at least 90 percent of their total federal income tax liability throughout the tax year, rather than in a big chunk come April. If you don’t make that 90 percent target, you could be subject to penalties.
The penalty amount varies, but can be several hundred dollars. The average penalty was about $130 in 2015, according to the IRS.
And as the gig or sharing economy has grown, the IRS has seen a growing number of taxpayers subject to estimated tax penalties. The number of levies jumped from 7.2 million in 2010 to 10 million in 2015, an increase of nearly 40 percent.
What can you deduct?
The key to reducing all tax bills is reducing the amount of income that’s subject to taxation. If you’re self-employed, you can accomplish this by carefully tallying all your gig-related expenses and, if filing as a sole proprietor, claiming them on Schedule C.
Gig workers, however, need to be especially mindful of expenses that are partially personal and partially business.
Take, for example, an Uber or Lyft driver who uses a personal car for the app-hailed jobs. You must divide your personal and business expenses, either based on actual expenses or by using the standard mileage rate.
If you use the actual expense method, you can deduct the business part of auto costs, such as depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance and registration fees. Or you can opt to instead use the standard mileage rate, which requires only that you keep good track of the distances you drove paying passengers.
Just note there are times when you have to use the actual expense method and there are times when you can’t use it.
- If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business.
- You must use actual expenses if you used five or more vehicles simultaneously in your business (such as in fleet operations).
- You cannot use actual expenses for a leased vehicle if you previously used the standard mileage rate for that vehicle.
Ordinary and necessary expenses
In order to qualify as a deduction, a business expense needs to be both ordinary and necessary.
- An ordinary expense is an expense that is common and accepted in your field of business.
- A necessary expense is an expense that is helpful and appropriate for your business — it does not have to be indispensable to be considered necessary.
These distinctions are important for gig economy workers, who might find that expenses needed to execute their various contract jobs are different from general business operation costs.
Look again at an Uber or Lyft driver who provides passengers with bottles of water, candy or other refreshments, and maps of the city to help them get around. In most cases, eligible deductions for meals and entertainment is limited to 50 percent of the expense. Some tax pros and software contend that the car-for-hire contractor is subject to this limitation.
Eva Rosenberg is not part of that group. Rosenberg, a California enrolled agent federally licensed to represent taxpayers in collections, audit and appeal proceedings before the IRS, is the internet’s original TaxMama® and author of several small-business tax books. She says that a good cab driver — and she includes Uber et al. chauffeurs in this category — needs to have supplies in the vehicle.
Using the tax code’s designation of an expense that’s necessary for a particular trade or business, a cabbie or ride-for-hire driver could claim such things as sanitary wipes, tissues and even light refreshments, according to Rosenberg.
“Those can reasonably be treated as supplies, rather than meals,” says Rosenberg. “They don’t rise to the level of a meal, so you don’t need to reduce the costs by 50 percent.”
Record keeping required
Regardless of what you deduct, the side hustle deduction possibilities underscore the importance of keeping good records.
The IRS tends to look closely at independent contractor tax returns because so much on their 1040s is not corroborated by third-party tax statements. The interest is warranted, judging by the $458 billion tax gap — the difference between the total tax liability for American taxpayers in a given year and the amount they actually pay on time. People who don’t file, who underreport their earnings or tax liability, or who underpay their taxes contribute to the gross tax gap. The net tax gap is the amount the IRS will never recover through enforcement or other late payments.
The IRS relies on all taxpayers to be honest, but it also reserves (and exercises) the right to question — that is, audit — tax returns it suspects might be less than complete.
As your work life changes, be it through added side hustles or a more permanent employment opportunity, taxes will continue to play a major role.
You will likely want to make the most of your side gigs by minimizing your tax liability. And be sure to keep in mind that changes in your life, not just your job, will affect your taxes.
Finally, pay close attention to each year’s tax return as you file it using Credit Karma Tax™, a free tax-preparation and e-filing service. Credit Karma Tax™ supports many of the forms you’ll need to file your taxes as a self-employed individual, such as Schedule SE for Self-Employment Tax and Schedule C for profit or loss from a sole proprietorship. Your annual Form 1040 is a good guide as to how taxes affect your life and what you can and should do to reduce them.
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