💰 Extra Income, Extra Confusing? Demystifying Side Hustle Taxes

☕ Good morning!

Today, we’re looking at how taking on extra work outside your main job can not only boost your income but also significantly speed up your financial strategy. A few reasons someone fully-employed may want to moonlight include:

🛠️ Expand your professional skillset and adaptability in the job market.

🔗Build new professional connections that can open doors to future opportunities.

💼 Supplement your income, providing more financial flexibility for savings, fun, or the rising cost of living. 

🎯 Engage in work that may align more closely with your personal interests or long-term career goals.

However, as you may have guessed, given the nature of our newsletter, the extra income and opportunities come with important tax considerations that need careful handling.

Let’s get into the details and help you keep more of what you earn!

Moonlighting 101: Understanding the Basics

Earning through platforms like Upwork, or even part-time gigs, not only boosts your income but also diversifies your skills and expands your network.

No matter your profession—be it a software engineer diving into freelance gigs or a marketing executive exploring side hustles— the tax implications can be significant if not carefully planned for.

For example, if you’re in the highest tax bracket already from your salary income, every dollar from side hustles could be taxed as high as 60% or more in a high SALT region. 

However, self-employment comes with numerous perks that can help provide some tax relief. 

🌝 When you moonlight, the IRS considers your efforts self-employment, meaning different tax rules apply than those of your day job.

That means a few extra forms you may have never seen before:

Form 1099-NEC is the form you should get if you earn over $600 from a client. You might need to remind your client to issue this, as it can be easy to forget. This should be done for every client over $600.

To get a 1099-NEC, you’d need to fill out Form W-9 and send it to your client. It’s straightforward and basically contains your taxpayer information.

Schedule C (Form 1040) is where you declare your moonlighting income and expenses.

⚡The stinger is self-employment tax, which covers your dollar’s fair share of Social Security and Medicare. 

Unlike traditional employment, where employers withhold taxes, moonlighting income attracts a 15.3% self-employment tax.

This is on top of your regular income tax and potentially state, city, and even AMT tax.

The silver lining is that self-employment tax applies to net earnings, not gross income, from self-employment. This means you first subtract any allowable business expenses from your gross income to determine your net earnings.

You can also deduct the employer-equivalent portion of your self-employment tax on your income. Essentially, you can deduct half the self-employment tax (which corresponds to the employer's portion if you were an employee) on your personal income tax return, which helps to reduce your overall taxable income.

Let’s say you calculated self-employment tax of $1,000; you could deduct $500 from your taxable income when you file your personal income taxes. 

⏰ There are a few more key considerations for efficient moonlighting tax management. 

🧮 Without automatic withholding, you're responsible for paying estimated taxes quarterly to avoid penalties. Missing these deadlines can lead to unnecessary fines.

🤖 Use tools like the IRS Tax Withholding Estimator to determine how much to set aside. Considering federal, state, and self-employment taxes, a safe rule of thumb is to reserve about 40% of your moonlighting income for taxes.

📂 Meticulously track every quarterly payment and expense to prepare yourself for tax season and make sure you maximize your potential deductions. 

❓What if I forget to pay my quarterly taxes? How bad is that penalty?

The penalty is calculated based on the amount of underpayment, the period of underpayment, and the IRS interest rate for underpayments.

The penalty applies to each installment of the estimated tax that you failed to pay on time. If you underpay, the penalty is calculated separately for each required installment. Use Form 2210 to figure out your penalty. 

The period of underpayment runs from the due date of the estimated payment until the date you make the payment or the due date of your return, whichever is earlier.

The penalty rate is the federal short-term rate plus 3 percentage points, adjusted quarterly. For example, if the federal short-term rate is 1%, the penalty interest rate would be 4%. In 2024, the interest rate for underpayments is 8%.

Your tax filing software or tax preparer will also likely calculate the penalty at the end of the year.

💸 The power of strategic deductions: more is less. 

One of the most effective ways to maximize take-home pay when moonlighting is to use deductions to offset your income strategically. 

Understanding what you can deduct and how to document these expenses properly can significantly decrease your taxable income, thereby decreasing the amount you pay in taxes. 

Here are a few popular deductions you may consider:

Is your side gig also a side quest for new skills? Costs for education and training (including seminars, workshops, and classes) necessary to maintain or improve skills required in your current business might be deductible. 

 If you use a part of your home regularly and exclusively for business activities, you may be eligible for the home office deduction. This could be a percentage of your rent, mortgage interest, property taxes, utilities, maintenance, and repairs. 

You can deduct all supplies and equipment purchases essential to your side gig work, such as computers, software, office supplies, and furniture.

If the equipment is used exclusively for business purposes, the full amount can be deducted. If it's used for both personal and business purposes, you'll need to calculate the percentage used for business and deduct that portion.

If your side gig requires travel, you can deduct many associated costs, including airfare, hotels, car rentals, and 50% of your meals during business travel. If you use your car for business, you can choose between deducting actual expenses (like gas, maintenance, and insurance) or using the standard mileage rate (67 cents per mile for 2024.)

Fees for legal, accounting, and other professional services, such as financial planners, that are directly related to operating your business are fully deductible. 

Expenses to promote your side business, such as website development, maintenance, hosting fees, business cards, and advertising, are deductible. 

❓What if my expenses exceed my side hustle revenue? 

If your business expenses exceed your income, you can typically deduct the loss from your overall income, which can reduce your taxable income. 

This is reported on Schedule C (Form 1040), Profit or Loss from Business.

If your business operates at a loss, you may be able to carry this loss forward to future years, offsetting future taxable income. The rules for NOLs have changed under recent tax laws, so it’s important to check the current IRS guidelines. For more details, check out the IRS page on Net Operating Losses. 

In the eyes of the IRS, a business and a hobby are two different beasts. If your side hustle doesn’t show a profit for three out of five consecutive years, the IRS may classify it as a hobby rather than a business, and hobby losses are not deductible against other income.

In other words, you can’t just whip up a travel blog and begin claiming all of your flights, AirBnbs, and meals for inspiration and content’s sake– at least unless you have a reasonable means of turning it into a profitable business venture within that timespan.

 For more information, check out the IRS guidelines on hobby losses.

There’s nothing wrong with claiming business expenses, but make sure they’re ordinary and necessary for your business, as the IRS may scrutinize excessive or unreasonable expenses. 

You should be able to justify and provide substantial evidence for why each expense is essential to your business operations. For more information, visit the IRS guidelines on business expenses. 

🌟 Making Cents of Extra Income from Moonlighting

It’s not unheard of for the average high-earner to make a few extra thousand a month (or week) on the side.

After all taxes are accounted for, that extra income could mean a wide variety of perks… you could stuff your retirement accounts through legal strategies like Backdoor Roths or a Mega Backdoor utilizing your employer-sponsored 401(k) plan.

You could use a 529 Plan to supercharge your kid’s college fund.

You could tap into the Health Savings Account triple tax advantage, where your pre-tax contributions reduce taxable income, grow tax-free, and can be withdrawn tax-free for qualified medical expenses. 

Or you could just spend it on an amazing vacation– it’s your money! 

Remember, successful moonlighting isn’t just about earning more—it’s about earning smart. 

It also urges you to set a cost to your idle hours, which can be a scarce resource in demanding careers. 

If you’re committed to making some moonlight money moves, here’s how to ensure you remain on top of your game

 Leverage your time and resources by working with professionals who can help you manage the tax implications of multiple streams of income. 

Given tax law complexity and the nuances of every individual case, consulting with a financial planner specializing in self-employment to navigate deductions, estimated payments, and retirement planning effectively. Get started with free Financial Analysis to explore how some tax strategies specifically apply to high moonlighting income, helping you keep more of what you dedicated time to earn. 

Separate your finances to make filing easier for you. Use a dedicated bank account and credit card for your side business to streamline tracking and tax reporting. The last thing you want to be doing is unnecessary extra work come tax time. 

Until next week! 

Dan from Tailored Cents

P.S. Follow me on LinkedIn for more tax gems to save you money.