Side hustles are great for bringing in a little extra income. But they’re also a big help at tax time. That’s because people who are self employed — even if they’re only self-employed for a few hours a week — get a litany of tax deductions that are not available to employees. And, while a few of these breaks are nothing to crow about, these 4 great tax breaks for side hustlers can save you thousands of dollars.
Tax breaks for side hustlers
To explain, the Tax Cut and Jobs Act of 2017 eliminated many itemized deductions for employees. However, it kept and improved tax breaks for small businesses, including sole proprietors. If you have self-employment income, whether that’s rental income through Airbnb or tutoring pay from Wyzant, these tax breaks apply to you.
For the most part, however, the breaks are modest. For instance, self employed individuals have the ability to subtract business-related expenses from business revenue and only pay tax on the net profit. This allows Uber and Lyft drivers to deduct the cost of gas, maintenance, repairs and car washes (among other things) on their taxes. However, since those are all costs of doing business, these deductions only help you defray a portion of your costs.
However, 4 great tax breaks for side hustlers allow you to deduct expenses that are normally considered personal or enjoy tax benefits that go above and beyond recovering your basic costs. If you can take full advantage of them, they can save you thousands of dollars in federal income tax.
Those 4 great tax breaks for side hustlers?
Home office
If a portion of your home or apartment is used exclusively for your work, you can take a home office tax deduction. This deduction allows you to write off a portion of your rent or mortgage, as well as utility, maintenance, property tax and other expenses.
Let’s say, for example, that you live in a two-bedroom apartment that has 1000 square feet of living space. Your rent is $1,000 a month and you’ve converted one 250-square-foot bedroom into an office that you use exclusively for work and work storage.
Because that office commands one-quarter of your space, you can deduct one-quarter of your rent — $250 per month — as a home office expense. That $3,000 deduction would save someone in the 25% tax bracket $750 in federal income tax. Additionally, if you pay another $100 a month in utility expenses, one quarter of that is deductible too.
Any other expenses you might have to set up and maintain your office — desks, computers, chairs, printers, software, etc, — are also deductible expenses for the self-employed, regardless of whether or not you take the home office deduction.
Tougher for homeowners
For homeowners, the home office deduction gets far more complex. In this case, you get to “depreciate” a portion of the value of your home and write off a share of your property taxes, insurance and maintenance costs, too. But, if you later sell your home, you will need to “recapture” the portion of the home that you previously depreciated. If your home is expensive or your office is big, this may still be worth the trouble. But, you should enlist the help of a tax accountant to get the details right.
There is an alternative, however. The IRS provides a safe-harbor home office deduction that amounts to $5 times the number of square feet of the home office to a maximum of 300 square feet. That gives you a maximum deduction of $1,500. But there’s no need to “recapture” anything.
The only catch? If you’re ever audited, the IRS will need to know that the office was used for nothing but work.
In this age of stay-at-home/work-at-home orders, I’m sure a lot of people are wondering whether this deduction is available to employees. No. The 2017 tax law stipulates that it’s only for the self-employed.
Health insurance
Another big deduction that’s not available to employees, but is available to those with self-employment income: write-offs for health insurance premiums.
Self-employed individuals who buy health insurance for themselves and their families can deduct 100% of the annual premiums. So, if you’re paying $500 a month, you have a $6,000 deduction that would save someone in the 25% tax bracket $1,500.
You can also deduct the cost of a qualified long-term care policy for you, your spouse or your dependents.
Rental exclusion
If you rent a spare bedroom through Airbnb or rent your house out by the hour to photographers and filmmakers through sites like Giggster and Peerspace, you should know about the 14-day rule. In a nutshell, this rule says that income from renting your personal residence for 14 days or less is tax free for federal income tax purposes. If your state conforms with federal tax law, and many do, it would be free from state tax, as well.
It doesn’t matter whether the rental brought in $500 or $50,000 during those 14 days. As long as the home qualifies as your residence and you don’t rent your home for a single day more, none of this income is subject to federal tax.
However, if you rent the home for even one extra day in that same tax year, all of the income goes back into the taxable column. So, think twice before accepting longer bookings.
Paying your kids
Another funky but highly lucrative tax break allows self-employed people to hire their own kids — even really young kids — and deduct all the money that they pay them.
The child doesn’t need to pay any tax on this income until he or she earns more than the standard deduction for a dependent. That standard deduction amounts to $12,400 in 2020, according to Mark Luscombe, principal tax analyst with Wolters Kluwer.
What does this do? It takes income out of the presumably higher-earning self-employed person’s tax bracket and moves it into a low- or no-tax recipient. Since that recipient is your child, you can also dictate (to some degree, at least) what he or she does with the pay. You might, for example, require the child to save a portion for college or use the money to pay personal expenses that you might otherwise shoulder.
You do, however, need to pay a reasonable amount for the service your child is providing. And you should be able to justify the business need.
What would be legit? Hiring your 15-year-old computer whiz to handle updating and troubleshooting your business website. If you’d pay outside help $1,000 a month for that, that’s a reasonable amount to pay your child too.
Some business owners say they’ve hired their kids to model for their advertising, stuff envelopes, deliver packages, and answer phones and email.
Notably, if you pay less than the $12,400 annually, your child won’t pay any income tax on the money. And, if the child is under the age of 18, this employment arrangement is also exempt from Social Security and Medicare taxes.
One final note: Keep good records. Tax audits are rare, but they’re less rare when you’re self-employed than they are for employees.
Published: 1/20/2021
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