In a word, yes. Any time you earn income for doing a job — whether for a permanent employer or as a freelance gigging side hustler extraordinaire — you need to report that money to the IRS and pay your fair share of taxes on it. This is true for almost any payment you receive, including gift cards from iPoll or Swagbucks.
Getting in to the world of freelancing can be confusing when it comes to filing your taxes, and you may be tempted to believe it when someone in a chat room tells you that there are ways to get around paying taxes on your side gig dinero. Don’t believe it! Tax fraud is a big deal, and it’s not worth it if you get audited.
Here’s what you need to know about paying taxes on all your side hustle money so you can stay sane — and legal — as you build your savings the old-fashioned way.
What to Expect When You’re Not an Employee
If you’ve ever had a job with a regular employer, you already know what a typical paycheck looks like. There’s your gross pay — that is, the money you earned — and there’s your net pay, which is what you’re left with after all the deductions your employer takes out for things like Social Security, Medicare, plus federal, state and local taxes. It can be a bummer, but at the end of the year you also get a W-2, which spells out exactly how much earned and how much you’ve already paid toward your taxes through withholding.
Doing taxes with a W-2 form is a piece of cake, and it’s so uncomplicated that you might even be able to use a 1040EZ form.
When you start side gigging, however, your tax picture get complex pretty quick. If you work as an independent contractor for a big company, you’ll be issued a 1099 form outlining what they paid you over the course of the year. This form is pretty simple, since they don’t take out any taxes for you. Businesses aren’t required to send you a 1099 if you made less than $600 for the year, but don’t be fooled: You still have to claim that income even without a form, usually as “gross receipts” for your side business.
And all the little odd jobs you do around town for $25 bucks a pop? Gross receipts.
You need to keep track.
It’s a good idea to keep a running list of your income from every source throughout the year, especially if you don’t get 1099 forms from a bunch of them. On the bright side, you should also keep track of any business expenses you make, like special tools for the job or the laptop you use for online work, since you’ll be able to deduct these business expenses to help balance things out.
How to Pay Your Taxes
Once you add up all those income sources and enter the numbers into your tax preparation software (or take them to a tax pro, if you’re fancy), you’ll find out exactly how much you owe. People who have taxes withheld by employers often get a refund because they actually overpaid their taxes over the course of the year.
Hate to break it to you, but this almost never happens to freelancers.
Because none of your income had taxes withheld, you’re going to owe a bunch by the end of the year. If you have a regular job and a small side job, you might find that you break even: The refund you would normally get from your W-2 income might cover what you owe on your 1099 income.
When you earn a lot of your income from 1099 work or from your gross business receipts, things get tricky. The IRS gets mad if you underpay your taxes throughout the year, and they’ll slap you with an underpayment penalty if you owe too much at tax time — the definition of adding insult to injury.
To avoid this, you can pay your estimated taxes quarterly. Sharpen your pencil and use IRS Form 1040-ES to figure out what your quarterly tax payments should be. This is done by making your best guess at how much you’ll earn over the year and following the directions to determine the taxes for each quarter. Then every three months you send a check (or have an automatic withdrawal) for that amount to keep up with your tax payments. At the end of the year, you’ll be able to list those payments on your tax form to offset the amount you owe. This also works for your state taxes, though you’ll have to check for the rules in your own area.
It’s not always easy to make an accurate guess about how much you’ll earn in a year, but a good rule of thumb is to use last year’s income and add ten percent just to be safe. The silver lining is that if you end up overpaying, you’ll get a refund.
Setting Money Aside for Taxes
One of the hardest parts about freelancing is being your own tax man. Every time you get a check, you have to keep in mind that it doesn’t all belong to you. To keep yourself from overspending and getting in a jam when you find out you owe money to the government, you should open a savings account dedicated to your tax savings. Each time you get paid, transfer the percentage of that check you’ll owe in taxes directly to the savings account. When it comes time to make those quarterly tax payments, you’ll be able to do so directly from this account.
And if you get a refund, you can keep it here, too, to avoid spending it on something frivolous. This way you have a solid cushion for your tax expenses, and you can even earn some interest on your money while it’s still yours — the major drawback of having income tax withheld from your paycheck.
Having a side gig means staying organized and keeping track of your cash, but the results are definitely worth it. Got any tips to share about tax time? Tell us in the comments!