Side hustling is an amazing tool to pay down debt, learn new skills, figure out what you want from your career, and enjoy many other benefits.
While the benefits of side hustling seem magical, side hustle income isn’t magical to the IRS. You’ll still need to pay taxes on this income, including “both sides” of Social Security and Medicare taxes.
As a side hustler, it’s important to figure out how to handle taxes for your side hustle so you don’t end up with a tax nightmare on the night before the tax deadline. Thankfully, handling taxes for your side hustle doesn’t need to take a lot of time or hassle. Below are the four steps you'll want to take.
1. Track Your Income And Expenses
The amount you have to pay in taxes for your side hustle boils down to your income and related expenses. When you track those two carefully, it will be easy to figure how much you owe in side hustle taxes.
Tracking income and expenses can be as simple as writing your income on a piece of paper and storing your receipts in a shoebox. Of course, such rudimentary record-keeping can make tax time more difficult. A simple, online system such as the one laid out below may be a better solution.
The Ideal Setup
The ideal setup for tracking income and expenses minimizes the time and effort spent on keeping records. If you set up your accounts well, you can keep the time spent on side hustle finances to just a few minutes per month.
Every side hustler will have a slightly different financial system. After several years of experimentation, my ideal “side hustle” setup involves three dedicated accounts just for my side hustle.
- A business checking account. All income (including income from PayPal) goes into this account.
- A rewards credit card. All legitimate side hustle expenses are paid on this credit card (or directly from the checking account if I can’t pay by card). Money in the checking account pays off this credit card.
- A business savings account attached to the checking account. This account is used for paying taxes.
Anytime I earn money from my side hustle, it is immediately contributed to the “side hustle” checking account. When I have a side hustle expense, I use the business credit card to cover the expense and pay it off each month.
Once I’ve set aside money for side hustle taxes (more on that later) in my savings account, I transfer the remaining money to my personal checking account. That money can then be used as part of my regular spending (or for other savings goals).
Each quarter, I make an estimated tax payment. I use around two-thirds of the money from the savings account to pay those taxes. The rest of the money goes into a tax-advantaged retirement account.I happen to track my income and expenses using Tiller. However, another online accounting software could work as well. Most years, TurboTax bundles a one year subscription of QuickBooks with its highest Self-Employed tier.
Help! I Used My Personal Checking Account For My Side Hustle
If you’re like most new side hustlers, you started earning money first, and then figured out that you need a system. Tracking your income and expenses after the fact is a hassle, but it is possible.
Back-Tracking Your Side Hustle Income
The income side of the equation tends to be the easiest. If you are hustling online, or working for a few dedicated clients, they will need to send you 1099 Forms at the start of the tax year.
Or if you’ve used PayPal to receive income, you can get reports from PayPal that categorize your business income.
Back-Tracking Your Side Hustle Expenses
Expenses can also be fairly easy to track down at first. Rideshare drivers can use their app to check mileage. Specific purchases such as a computer, software, or materials can be tracked through your bank statements or online purchase history. Once you have your income and expenses sorted out you can subtract expenses from income to determine your profits to date.
Of course, not every side hustler will have a simple financial picture. For example, someone who moonlights as a handyman, a babysitter, or a face painter for children’s parties will inevitably have more complex finances.
These kinds of side hustles may have income from many sources (including cash payments, checks, Venmo and more) and a variety of expenses. In these cases, you may need to export all of your banking transactions to an Excel spreadsheet or Google Sheet and classify each transaction line-by-line.
2. Set Aside 35% Of Your Profits For Side Hustle Taxes
Side hustlers will generally want to set aside at least 35% of their profits for taxes. If you’re not a super-high income earner the 35% rate may seem astronomical to you. However, this tax rate is broken into three components.
- Self-employment taxes. The self-employment tax rate is 15.3% of your profits. Of those taxes, 12.4% goes towards Social Security and 2.9% goes toward Medicare. When you’re self-employed, you are technically both and employer and an employee. That means you have to pay the employer half of Social Security taxes as well as the employee half. These are your FICA taxes.
- Federal income tax. Federal income tax is money you pay to the federal government for earned income. There is some debate as to whether you should set aside tax money at your marginal tax rate or your effective tax rate. But since side hustle income is money you earn “on top” of your typical day job, setting aside money based at your marginal tax rate is the safest best.
- State income tax. Not every state has an income tax. However, if you live in a state with an income tax, it can add anywhere from 0.33% to 13.3% to your tax liability.
After a year or two of side hustling you may find that the 35% rule of thumb is too high or too low for you. Adjust it as needed. Just be sure you never go lower than 15.3% of profits. You will definitely need to pay your self-employment taxes, even if you can avoid most other income tax.
Help! I Didn’t Set Aside Any Money For Taxes
If you didn’t set aside any money to pay for side hustle taxes, don’t panic. It’s not ideal, but it is a solvable problem. Start setting aside 35% of your side hustle income for future tax payments. That way, this won’t be a problem again next year.
Next, start the process of filing your taxes. Tax software or an accountant can help you figure how much you actually owe this year. First time side hustlers may be pleasantly surprised to find they don’t owe the IRS much at all. If you're accustomed to getting a tax refund, and you haven’t earned too much through your side hustle, over-payments and under-payments may have cancelled each other out.
Third, move forward with filing your taxes for your side hustle income. Don’t wait to file because you owe money. It is far better to owe back taxes than it is to delay filing.
Finally, if you owe money, decide the best method to pay your tax debt. People with good credit may qualify to pay their back taxes using a 0% APR credit card. This will transfer the tax debt to a credit card, and could give you 12 to 18 months to pay back your taxes at a 0% interest rate. If you can’t qualify for a low interest rate credit card or loan, consider an IRS repayment plan.
3. Make Quarterly Payments On Your Side Hustle Taxes
Most years self-employed people are required to make estimated tax payments once per quarter. Ideally, you will pay one quarter of what you owe each quarter.
When you file your side hustle taxes the following year, you will come away neither owing money nor being owed. Typically, quarterly payments are due on the following schedule:
- Quarter 1 due April 15th
- Quarter 2 due July 15th
- Quarter 3 due September 15th
- Quarter 4 due January 15th
If you make the payments late, or you underpay throughout the year, you may have to pay some amount in interest each year.
4. Lower Your Side Hustle Tax Liability
When you first start side hustling, the tax burden may feel overwhelming. It’s especially tough to start paying both sides of the Social Security and Medicare taxes.
However, there are two legitimate methods for lowering your side hustle tax burden. First, you can write off all your legitimate business expenses. Second, you can take advantage of normal tax deductions and credits.
Write Off Legitimate Business Expenses
Side businesses offer a few opportunities to increase your tax efficiency. You may qualify for certain legitimate tax write-offs that you didn’t qualify for prior to owning a business.
Any expense that is considered an “ordinary” part of doing business and an “expected” expense in a business can be written off. For example, you can probably write off the following expenses:
- Costs of software or apps needed to conduct your business. (This includes bookkeeping and tax filing software in most cases).
- Tools, equipment or electronics needed to do your side hustle. (Note, computers and other electronic devices have to meet the definition of business equipment laid out by the IRS).
- Mileage expenses if you drive for your side hustle (Use an app to track your mileage).
- Dedicated home office expenses.
- Any contract labor expenses (including bookkeepers, accountants, virtual assistants, people you hire on Upwork, etc.).
- Bank or payment processing fees.
- A portion of your internet or phone expenses (the portion related to business).
- Educational expenses including books, conferences, and courses.
- A portion of your utilities if you maintain a home office.
- Certain insurance premiums related to your side hustle.
Keeping good records will allow you to maximum your business expense write-offs. And with each written off expense, you lower your business profits. That translates to lower self-employment and income taxes for your side hustle.
Take Advantage Of Normal Tax Deductions
On top of business write-offs, most side-hustlers can benefit from putting money into tax-advantaged retirement accounts.
The main self-employed retirement plans include a SEP-IRA, a Solo 401(k), and a SIMPLE IRA. Contributing money to these accounts allows you to defer paying federal Income tax on the amount you contribute to the plan (up to certain limits). You won’t have to pay taxes on the money in these accounts until you withdraw the money (ideally during retirement).
If you have access to retirement plans at work, you may want to consult a tax professional to understand which retirement account makes the most sense for you.
Hannah is a wife, mom, and described personal finance geek. She excels with spreadsheets (and puns)! She regularly explores in-depth financial topics and enjoys looking at the latest tools and trends with money.