If you're one of the many people who have started a side hustle during the pandemic, remember, taxes are a little more complicated as a business owner.
Now that the IRS has moved back Tax Day to May 17, there's extra time to figure it out and file and pay your federal taxes for 2020. (Though if you pay estimated taxes for your side hustle or small business, those Q1 payments are still due April 15.)
Tax pros say the most common mistakes they see side hustlers make involve missing out on business deductions. Here's what you need to know, and how to avoid an unnecessarily high tax bill for your side hustle income.
Mistake No. 1: Not knowing you're launching a business when you start a side hustle
Experts say the first thing to know about doing side hustle taxes is that, if you have a side hustle that makes money, you have a business, even if you haven't incorporated or formed a limited liability company (LLC). You're what's called a sole proprietor.
Even if your side hustle is picking up groceries on Instacart or selling products on Etsy, you can still take advantage of the tax benefits that come with having a business, tax pros say. You'll detail that business income and deductions on a tax form called the Schedule C.
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The tax code favors entrepreneurs because you only pay taxes on your net income — that is, your income minus expenses — rather than your gross income like a regular salaried employee, says Sheneya Wilson, a CPA and the founder and CEO of Fola Financial. So not making the most of your deductible expenses has a big impact on your tax bill.
"You want to make sure you are maximizing your deductions, understanding what 'ordinary, necessary' [business expenses] means, and how you can minimize your tax liability as a freelancer or creative or entrepreneur," Wilson says.
Mistake No. 2: Not keeping records of your business expenses
Not tracking expenses is a common mistake side hustlers make, says Jeffrey Levine, a CPA and the chief planning officer at Buckingham Wealth Partners. Disorganization creates a problem from a tax-reporting perspective, he says, because when you don't have a good record of your expenses, it makes it harder to ensure they are properly deducted on your tax forms.
To fix the problem, Levine suggests using apps on your phone to keep your expenses in order as you incur them: "Go online and you can google 'top five self-employed apps' or 'top five business apps' and you will see a lot of options out there."
Tracking your expenses will make your future self happy, Levine says: "If you want to make your life easier when it comes to tax time as someone who has a side hustle, keeping good records is one of the best ways to do that."
Mistake No. 3: Being afraid to deduct business expenses
A related big mistake Wilson often sees freelancers make, she says, is being afraid to deduct expenses. The IRS stipulates that businesses can deduct expenses that are both ordinary and necessary. So for a person who teaches English online as a side hustle, supplies used to teach the course could be deductible.
Or if you sell goods online, you may be able to deduct the cost of purchasing those items or the raw materials to make them, along with expenses including technology fees for sites like Canva or for a web domain to host your website using Squarespace or Wix.
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Your vehicle provides another opportunity for a business deduction, says Levine. Many people drive for their side hustle, even if they don't work for a ride-sharing service such as Uber or Lyft. If you use your car to drive for business purposes, like driving to different clients' homes if you're a pet sitter, you may be able to deduct car expenses. But if you use your car for both personal and professional reasons, you must divide your expenses based on mileage.
"You are entitled to take deductions for the expenses that are related to your business," Levine emphasizes.
If you have questions about your side hustle taxes, both experts agree: Contact a tax professional for help.
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