Taxes

A mixed bag for side-hustlers

The moment you picked up your first side hustle, you entered the world of the self-employed. And while self-employment offers real benefits for those who need flexibility and like the idea of being in control of their own destiny, it is a mixed bag when it comes to federal income taxes.

The first unpleasant shock for most: No one withholds income taxes from your side-hustle income, so you’re likely to owe money at the end of the year, says Jenna Ivanoski, gig-economy product manager at Tax Act. A simple way to fix this: If you (or your spouse) also have a day job with a regular employer, boost your withholding at the day job to account for the additional income you’re earning on the side. 

However, what might be a bigger unpleasant surprise is FICA.

FICA, which stands for the Federal Insurance Contributions Act, is the money that’s taken out of worker paychecks to pay into the Social Security and Medicare systems. Typically, workers pay 7.65% of their wages into this system and their employers kick in the other 7.65%. When you’re the employer, you pay both sides — 15.3% of your business income.

That said, you only pay this tax on what’s left of your business income after deductible business expenses. And business deductions can substantially reduce the income that you need to pay tax on. As a business owner, you are able to deduct far more than you could as an employee.

What’s deductible? Any expense that is reasonable or necessary for you to conduct your business. Those expenses are likely to differ by the type of side hustle you have. But they can include advertising and marketing costs, commissions and fees, insurance, office expenses, meals and entertainment, gas, repairs and maintenance, supplies, travel, eduction costs, and the cost of contract labor.

If you’re a Lyft driver and needed to lease a new car to conduct your business, for instance, your lease payments are at least partially deductible. (The deduction is limited to the amount you use the car for business, however.) You can also deduct the parking and tolls you pay, the cost of drinks and snacks for your passengers, maintenance expenses for your car. You might even be able to deduct the purchase of a new smart phone, if it was necessary for your business.

Sell on Etsy? The cost of your materials — and arguably most of the art supplies that might be used in the future to make your wares — are deductible.  If you took courses to improve your skills — or to learn how to market or present your business, those costs could be deducted too. Commissions and fees paid to the site, and any business related travel also can be subtracted from your business income. If you pay rent on an art studio, that rent is deductible, as are the other expenses of keeping up your office.

Do you advertise? Hire a publicist? Wine and dine prospective clients? Did you hire someone to create a professional Facebook page or handle your social media? All of these expenses are deductible in full or in part.

The key, however, is keeping good records to explain why, say, a costly meal might be a legitimate write-off. (Hint: Taking out the company’s top client to discuss news business ventures is a good explanation for the write-off; taking your spouse out because it was an exhausting work week is not.) Documentation for your deductions is not required at the time of filing. However, it could be required later, if you are audited. And though audits are relatively rare, self-employed people are audited far more often than employees. Make sure to keep your records for at least three years.

It’s also worth mentioning that the fees you pay to a tax preparer are also deductible. And when you are self-employed, you are far more likely to face vexing tax questions that make hiring a professional advisable.