So you're earning good money from your side hustle, but are you making sure it's all tax compliant?
“Even experienced tax paying contractors have no idea how much money they need to set aside to pay taxes," says Caroline Bruckner, executive in residence at the Kogod Tax Policy Center at American University. This under-reporting trend can put gig workers in the cross-hairs of auditors for failing to pay their fair share, while robbing them of their retirement income.
These contractors aren't all miscreants trying to cheat the system. In most cases, they just don't realize the tax implications related to gig work, says Garrett Watson, special project manager for the Tax Foundation in Washington, D.C. “Most of them have regular jobs with a W2 wage, and an employer who withholds their filings," he says. They aren't accustomed to paying quarterly taxes, or tracking expenses so they can write them off later.
But when it comes to gig work, employees have to handle all of these tax requirements on their own.
Paying taxes as an independent contractor doesn't have to be complicated, but it does require you to pay careful attention to what you are earning—and what you are spending to make your business work, notes Paul Koullick, founder of Keeper Tax, an app that finds tax write-offs for gig workers by monitoring their payment history and bank statements. It can also be financially beneficial. Koullick's team recently conducted research using publicly available tax data from the IRS, alongside a retroactive analysis of 2018 tax returns. The research that found when gig workers do pay their taxes, they overpay by an average of 21 percent, because they don't know what they can write off or how to do it. That translates to about $400 for the average part-time gig worker, and $1,550 for gig workers making $25,000 per year, he says. “Some people are taking out loans to pay these tax bills because they don't know what to do."
Tax experts offered their advice on how to avoid overpaying while keeping the IRS off your back.
Even a simple side gig is still a small business. [...] You should have a separate account to keep track of what you earn.
—Caroline Bruckner, executive in residence, Kogod Tax Policy Center at American University
1. You have to pay quarterly taxes.
It's annoying and burdensome, but the current tax law says any independent contractor must make quarterly federal and state tax payments if they make more than roughly $12,000 per year. This includes advanced payments on the 15.3 percent self-employment tax (SE tax), which anyone earning more than $400 per year in gig work is obligated to pay. Watson advises gig workers to use their previous year's income or taxes to estimate quarterly payments, or to set aside about a third of their income for taxes to avoid penalties. If you really don't want to pay quarterly taxes, you can skip it, but you will have to pay a seven percent penalty, which equals about $280 if you earn $4,000 per year, Koullick says. “As you long as you know the trade-off, you can decide if it is worth it."
2. Even if you didn't get a 1099, you still need to pay.
A 1099 is an IRS form used to report income other than a traditional salary. In theory, any company that pays you that income will send a 1099 at the end of the year summarizing your annual payments. However, current tax law only requires gig-working platforms to send 1099s if a contractor does more than 200 transactions and earns more than $20,000 per year from that platform. As a result, the majority of gig workers will never get a 1099, Bruckner says. Many industry experts are campaigning for a change in the law, but in the meantime, gig workers need to keep track of their own income and pay taxes accordingly.
3. Gig workers have a lot of expenses—and a lot of write-offs.
“Understanding your costs is an important part of being a part of the gig economy," Watson says. He encourages gig workers to assess all of the assets and purchases they use in their gig work to track write-offs throughout the year. These can include wear and tear on your car or bike, gas payments, materials for products sold on e-commerce sites, and meals or other expenses spent to support the business. “You can deduct all of these costs on state and federal taxes, which will lower your tax burden," he says. But you have to keep track of them to write them off.
Don't worry if you lost that paper receipt, Koullick adds. “Bank statements are legitimate proof of any transaction, so even if you can't find your receipt, you can still make the claim."
4. Create a separate business account.
Bruckner suggests gig workers open a separate business account for purchases and payments to make it easier to track their income and write-offs. They can also take advantage of alerts, dashboards, year-end summaries, links to business management software, and other tools offered by some business charge or credit card companies to manage their income. “Even a simple side gig is still a small business," she says. “You should have a separate account to keep track of what you earn."
5. Don't be afraid to come clean.
If you are just now realizing that you've never paid self-employment taxes, or you missed your first quarterly payments, it's okay. “They key is to get back on the right track," Bruckner says. Catching up on missed payments not only reduces your risk of audits and penalties, it ensures you are contributing to your retirement income. “If you don't make those payments you won't get that social security credit benefit, which is significant for your retirement."
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