Getting your first influx of side hustle income can feel so exciting, whether you’re planning to use the extra cash to for something fun (lush vacation, anyone?), for a big financial goal, or to set yourself on the path of working for yourself.
That is, it feels exciting until you realize all of that money is not yours to keep.
If you live in the U.S., you’re required to report any income. However, if you are making more than $600 in gross income a year from your side gig, the payer is required to issue a 1099 tax form. And, unlike your income from a full-time job, those taxes aren’t automatically deducted from each paycheck—it’s all on you to figure out how to report side income on taxes and make sure the government is getting its cut.
I remember feeling very overwhelmed by my new tax requirements when I started my freelance writing business, but quickly found that the basics weren’t nearly as complicated as I expected. I chatted with Amy Northard, CPA—founder of The Accountants for Creatives—to get all the intel on side income taxes in the U.S. (plus some tips for how to keep as much of your hard-earned extra cash as possible).
Understand if you have a business or a hobby
Whether or not you consider your side hustle a fun hobby or a growing business, understanding how the IRS differentiates them will affect everything, from which forms you use to how much you owe in taxes.
The biggest difference, says Amy, is whether there is a profit motive. “With hobbies, a lot of times you’re doing it for the pure enjoyment of the craft, and you are just barely making enough money to pay for the supplies involved. If you're running a business, you are doing it to make a profit.”
Understanding the distinction matters because it affects how much of the income you’ll pay taxes on, because you can write off deductions for a business (more on that in a minute). “With a hobby, if you get $100, you pay tax on $100. With a business, if you only made a profit of $25, you only have to pay tax on that,” Amy explains.
"I usually try to encourage people to treat it like a business from the beginning. Even if you're doing a freelance job here and there, treat it like a business. It will make your life so much easier, and it will also help things grow."
So which one is your side hustle? The IRS has a list of factors they consider, but Amy says if you’re making any sort of profit or planning to in the future, she recommends filing as a business, both for the tax benefits and so you take your side hustle more seriously. “I usually try to encourage people to treat it like a business from the beginning. Even if you're doing a freelance job here and there, treat it like a business. It will make your life so much easier, and it will also help things grow,” she says. The only real downside is it makes filing your taxes more complex.
Learn all the new tax forms you’ll encounter
Okay, let’s do a quick rundown of all the new fields and forms you need to know when filing side hustle taxes.
If you’re treating your side hustle as a hobby, you’ll report the income on Schedule 1. If you’re treating it as a business and you operate as a sole-proprietor or LLC, you’ll report the income on Schedule C, and will also need to file a Schedule SE for self-employment tax. If you have multiple LLCs or multiple side hustles in very different industries, file a separate Schedule C for each one.
Either way, you will likely start receiving 1099s from any clients or payment processors (e.g., Square, PayPal) that sent you over $600 in a year. These are sent to you and the IRS to report the income they paid you, and should be filed away in your financial records.
You don’t need to file these forms along with your taxes—you’re just required to report the income itself—but you should report any discrepancies between what someone says they paid you and what they actually paid you (and are expected to report income even if you don’t get a 1099 for it).
Save for your taxes—or pay quarterly
A mistake a lot of new side-hustlers make is spending all the extra money they earn, and then not having enough in their bank account to cover the tax bill when it comes around.
To avoid that problem, Amy recommends opening a separate savings account that you move about 30% of your profit into.
Another good way to plan ahead (and avoid penalties) is to pay quarterly estimated taxes. Four times a year, you can pay the IRS about a quarter of what you expect to owe as a deposit towards your year-end tax. Amy offers a free quarterly tax calculator, or you can work with an accountant to figure out your payment, and you can pay these online. If you owe over $1,000 in federal taxes (the thresholds are often lower for state taxes), you’re required to pay quarterly estimated taxes, but Amy says the penalties aren’t too bad if you forget.
Make smart use of deductions to reduce your taxable income
As mentioned above, filing as a business means you can report business expenses as deductions on your Schedule C and not pay taxes on that income.
That said “we don’t just want people to spend for the sake of spending to reduce their profit,” explains Amy. Instead, figure out which of your normal operating costs are considered reasonable deductions, and make sure you’re tracking and reporting every single one.
“...we don’t just want people to spend for the sake of spending to reduce their profit.”
Amy says some common deductions that people don’t think about are expenses for a home office, mileage for work-related driving, and contributions to certain retirement accounts. There are plenty of lists online of common self-employment deductions, or you can work with an accountant to understand what applies to you.
Be diligent about tracking everything
When it comes to side income, it’s best to prepare for tax time all year round with solid bookkeeping. Amy recommends immediately setting up a separate business bank account and credit card (“It will make things a million times easier than having to sort through all of your personal transactions and try to remember what’s what") and also signing up for a bookkeeping software to track invoices and receipts for expenses (she likes Wave as a free, starter option).
How do you pay yourself from these accounts? If you’re a sole proprietor or single-member LLC, “You can just transfer to your personal account when you want to take money out of the business or pay yourself. It doesn't have to be a physical check, it shouldn’t run through a payroll software. And don't go to Target and use your business account to buy personal things and call that your paycheck,” Amy says.
Ask for help if you need it
While the basics of side income taxes aren’t as bad as people might think, an expert eye can help ensure you aren’t making any mistakes and are optimizing things to get the most back on your taxes. (For instance, if your business is consistently making a profit of about $50,000 or more, Amy recommends considering filing as an S Corp to save on taxes, which adds a lot of complexity).
That’s why one of the best investments I’ve ever made for my business is hiring a CPA to do my taxes each year (yes, I work with Amy). It gives me peace of mind, gives me more time and energy to do the things I’m actually good at in my business and, best of all, I can write off her fee as a deduction on my taxes.