How to Avoid an Unexpected Tax Bill as A Side Hustler or Gig-Worker

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If the idea of doing your taxes makes you uncomfortable, you’re not alone.

In DollarSprout’s recent Side Hustle Survey, 1 in 5 respondents said that they received an unexpected tax bill because of their side hustle or gig income. Discovering you’ll owe money to the government rather than receive a refund is a gut punch, and can often lead to extra side hustling just to pay your tax bill.

Those with a traditional 9-to-5 job have it a little easier; when they get paid, taxes are already taken out. There’s rarely a need to calculate how much they owe quarterly.

But if you have a side hustle or work in the gig economy, it’s not that simple.

Thankfully, side hustle taxes don’t have to be a mystery. Here are six simple tips to help you prepare for your taxes in advance, and avoid an unexpected bill come filing time.

1. Set aside a percentage of your earnings.

As a freelancer, it’s your responsibility to report your earnings and pay the taxes you owe, and you need to pay those taxes based on the gross income you receive.

Make sure you set aside 20% – 35% of your side hustle income to cover your tax obligations to the federal government, your state, and even your local government. These percentages are determined by several factors such as your level of income, marital status, and place of residence.

The money you pay in taxes covers a number of different things. For instance, your federal taxes, collected by the IRS, include your federal income tax as well as your self-employment tax that goes towards Social Security and Medicare. Your state and local government taxes may include an income tax or a business license fee tied to your income, so be sure to double-check with your local and state officials to determine the proper amount you need to set aside.

Start putting a portion of your income aside in a separate bank account from the first day you start freelancing. This will help you avoid playing catch up or digging into your savings every time taxes are due.

2. Track your revenue and expenses.

You can also minimize an unexpected tax bill by keeping good records of your expenses that were incurred related to your self-employed income.

For instance, if you drive for Lyft, keep records of the number of miles you drive and how much you spend on gas, maintenance, and car payments. If you dogsit with Rover, keep track of expenses for toys you purchase, miles driven to the dog park and clients’ houses, and pet food or snacks. And if you moonlight as a graphic designer, track all the software subscriptions, training you attend, or any hardware you purchased to get the job done.

Whatever side hustle you do, find a tracking system that works for you and keep it up to date. You don’t have to pay for fancy bookkeeping software, but there are products like FreshBooks designed to help you manage the books so tax time isn’t as stressful.

And most importantly, open separate bank accounts to keep your personal finances from co-mingling with the business.

3. Make quarterly estimated tax payments.

If you’re new to self-employment, it’s possible that you’ve never had to submit your own taxes. When you receive your monthly or bi-weekly paycheck from an employer, they’ve already taken the taxes out on your behalf. As a freelancer, that doesn’t happen. You are responsible for your paying your own taxes, and to avoid a large bill at tax time, it’s recommended that you pay quarterly estimated taxes throughout the year.

Failing to pay enough taxes throughout the year can result in underpayment penalties in addition to the taxes you already owe. Estimated taxes help keep you on top of your annual liability and the government’s cash flow funded.

To estimate how much you owe, look at your most recent quarter of income (ex., January – March) and apply the expected tax percentages according to your federal and state tax brackets.

Make sure you’re noting the due dates for paying your estimated taxes. Due dates for federal estimated taxes are typically January 15th, April 15th, June 15th, September 15th, unless the date falls on a weekend or holiday (in which case payment is due the following business day). City and local taxes are usually paid on an annual basis but check with your local regulations for the exact dates.

Keep records of these payments. They are an important part of your annual tax filing paperwork to determine eligible refunds or additional required payments.

4. Look at your previous year’s tax returns as a guide.

If this isn’t the first year with a side hustle, take a look at the forms you submitted last year as a reference for what to expect again. Did you deduct mileage from the business use of your car? Did you take the home office deduction for using a portion of your home specifically for business?

Make note of all the items you deducted and determine if you can deduct them again. And if you were surprised by a large tax bill last year, look at the amount of income you earned compared to your tax rate. This should help you plan ahead for what you’ve already brought home this year.

5. Report all of your income, even if you don’t get a 1099.

The IRS requires you to report all of your income, even if you don’t receive a 1099 form from your clients. This is another important reason to keep track of your bookkeeping with invoices and records of payments received.

Software such as Freshbooks can help you create and track invoices, record payments and deposits from your customers, and quarterly tax estimates paid.

6. Don’t be afraid to ask for professional help.

There’s a reason you see a ton of tax preparation advertisements every spring – taxes can get incredibly complicated.

While you may feel confident plugging in the numbers from your W2 into online tax software, adding more and more layers of income and expenses can leave you frustrated and feeling lost. It can also lead to potential mistakes or problems.

Find a credentialed tax professional who can help you navigate your self-employment taxes. Ask them to explain the work they’ve done and if they have any advice to make it simpler or easier for the next year.

There are plenty of affordable, qualified professionals to help you. Try to avoid anyone or anything that feels sketchy, like guaranteed refunds, or someone who tells you to trust them without giving you a reason to.

Save Now to Avoid a Big Tax Bill Later

To make sure you’re paying your taxes appropriately and on time, set up a system. You can use a simple spreadsheet or accounting software to track your finances. It might also help to keep a separate bank account and set reminders on your phone to keep track of the important dates and payments.

Take a look at your current federal and state tax bracket, check with your local officials, and set a portion of your income aside as soon as you get it. This will ensure you have enough to pay your taxes, and you won’t have to work extra to find the money.

Author
Ben Watson, CPA

When he's not busy keeping the books clean at DollarSprout as their vCFO, Ben is the founder of Fiscal Fluency, a personal finance and business coaching company. He’s also the co-creator of the Business Launch Kit -- an online course with simple steps to create a business without making a mess.

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