Side hustlers can 'pay less taxes by being organized,' says CPA — try these 3 moves

Tax expert: How side hustlers can set themselves up for success in 2022
Key Points
  • Do you have to set up a special entity when you start side-hustling? "Not necessarily," says Jeffrey Levine of Buckingham Wealth Partners.
  • "Time and time again, the business owners I have worked with over the years who keep the best records tend to on average pay the lowest amount of tax."

Whether they're pursuing their passions by night or just looking to earn a few extra bucks when they're not on the clock, millions of Americans have picked up side hustles. While the money you earn from an auxiliary gig can go a long way toward upping your financial flexibility, it also inevitably comes with some extra work (and a higher payment) at tax time.

The goal for taxpayers everywhere taxes is to pay as little as possible while following the rules. If you've been working hard all year, mid-April is not the time you want to start scrambling to make sure you're doing the right thing when it comes to your side-hustle income, says Jeffrey Levine, a certified public accountant and chief planning partner at Buckingham Wealth Partners.

"It's always important to plan ahead because you will pay less taxes by being organized," he says.

If you have a side hustle, your best bet to minimize stress along with your tax burden is to choose the proper classification for your business from the start and to continue to monitor your tax situation throughout the year, Levine says. "Starting ahead can save you money in the long term."

Here are three strategies he says side-hustling taxpayers would be wise to incorporate.

Choose the right business structure

If you're finding yourself thinking 'Is there something I'm supposed to do?' after you've decided to start your own side business, you're not alone, says Levine. "The answer is, 'Not necessarily,'" he says. "In many cases, if you have no other business structure, you are by default a sole proprietorship."

If you're just starting out, operating within this structure is a way to keep things as simple as possible, Levine says. "There is literally no difference between you and the business," he says. "You're filing the same tax return. Your business is reported on a Schedule C."

If you go this route, it's important to remember that you're drawing a salary from which you can withhold taxes, the way your employer might at your 9-to-5 job. "As profits increase from that business, so too does an individual's tax liability," says Levine. "This may create a need for estimated tax payments for the first time in an individual's life, or, at the very least, the need to be prepared for a much larger tax bill come April."

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If your side hustle is generating big profits, you might benefit from using a more complicated structure, such as an S corporation. "The primary benefit of an S corporation is that while the salary that someone pays themselves as an employee of their own corporation is subject to employment taxes, the profits of that business flow through to the individual's personal tax return without the imposition of employment taxes," says Levine.

Basically, if you're a sole proprietorship, you'll pay self-employment taxes on everything you earn. By paying yourself through an S corp, only the wages you pay yourself are subject to those taxes, while profits above and beyond your salary are treated as regular income.

In short, it's essential to pick the business structure that's right for you. These and other factors (such as say, insurance and privacy concerns) will drive which decision makes sense for your business, and it may be worth it to consult a tax pro before making any moves.

Trim your tax bill by contributing to retirement accounts

Ideally, your side hustle is bringing in plenty of income above and beyond what you're earning at your full-time job. And more money means more income taxes. One way to shelter some of that money from the IRS is to sock it away in a tax-advantaged retirement account.

Money contributed to plans such as traditional 401(k)s, IRAs, and IRAs for business owners known as SEP IRAs, lowers your taxable income for the year in which you made the contributions.

Having multiple gigs can often means having multiple accounts to choose from, which can quickly get complicated. One thing to note, says Levine, is that contribution limits on such accounts are generally "coordinated" across plans. If you have two 401(k) plans, for instance, you can contribute up to the 2022 limit of $20,500 across both accounts, rather than $20,500 in each.

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Which accounts you contribute to and in which combination makes sense will vary from taxpayer to taxpayer, Levine says, and your accountant may have an idea of which setup is best for you. But regardless of how you save, you're killing two birds with one stone.

As a long-term saver, "there is a real benefit to maxing out those retirement dollars," which will grow at a compounding rate from the time you invest until when you withdraw the funds in retirement, he says.

"And on top of that," he adds, "that can also help you keep your tax bill down if you have two jobs by putting more money into a retirement account through your side hustle that will reduce your taxable income."

Stay on top of your expenses

The best way to trim your taxes as a side hustler, according to Levine: Don't be that person who shows up to the meeting with your accountant with your receipts in a shoebox.

"Being an organized business owner will help you pay less tax," he says. "Time and time again, the business owners I have worked with over the years who keep the best records tend to on average pay the lowest amount of tax."

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In order to deduct eligible business expenses from your taxes, it's essential to know which of your financial transactions were personal and which were for your business. "The best advice nearly all the time, is to keep your business records and your personal records as distinct and separate as possible," Levine says.

That typically means setting up bank accounts and credit cards for expenses related to your side hustle that will make it easy for you and any tax professional to discern what's deductible and what's not.

It's a good idea to keep constant track of anything you might need come tax time, which could include receipts for purchases you made for the business or miles you've traveled while working your side hustle. Luckily, today's side hustlers and small business owners have technology that makes this an easier process than ever, Levine says.

"Today, we have apps that can help track your miles for business or non-business purposes. There are apps where you can take a picture of your receipt and instantaneously it's recorded forever," he says. "These are the types of things that business owners should look to establish early on and to use regularly."

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