Tax Traps To Avoid

Millions of people in the United States supplement their income by doing side gigs such as being a ride-hailing driver, an Airbnb host, an eBay seller, or other types of freelance work. Their revenue from their side business may help them make ends meet, but it also may put them in difficult tax traps.

According to the opinions of tax specialists, side jobs almost always qualify as self-employment, which results in various laws, extra tax forms, and a great deal of uncertainty for those who are used to submitting their taxes as workers.

According to Mackey McNeill, a CPA and personal finance expert in Bellevue, Kentucky, when individuals file their taxes for the first time with side employment, they are often taken aback by the amount of tax required to pay.

Additional retirement savings options and the opportunity to deduct costs legitimately incurred for a company are two of the tax benefits associated with having a side hustle. Sadly, many people who try to make extra money on the side don't take advantage of these chances because they need to know what they don't know. Here are some important mistakes:

Keeping Lousy Records

Self-employed people can take tax deductions for business-related expenses, including transportation, advertising, supplies, internet access, and other services they use to support their operations. However, according to McNeill, these deductions will need to be recorded and documented to pass an audit.

Instead of trying to figure it out after the fact, McNeill recommends keeping records as you move along with the process. Applications that keep track of mileage, such as MileIQ and Hurdlr, and apps that keep track of expenses, such as Expensify and Shoeboxed, might be useful.

The ideal situation for those who earn money on the side would be to have a separate checking account for all their extracurricular income and expenditures. It's also smart to get a credit card designated only for the company's use. According to McNeill, a credit card statement alone will not be enough to demonstrate the legitimacy of a company's spending to the IRS during an audit; they will also want a copy of the receipt. Since paper receipts might deteriorate or be lost over time, tax professionals advise scanning or photographing them instead of keeping them physically.

And while we're on the subject of tax experts, you should give hiring one some thought, particularly if this is your first time working for yourself. A qualified, certified public accountant (CPA) or enrolled agent can help you identify deductions while ensuring that you stay out of problems with the Internal Revenue Service (IRS).

Not Paying Taxes As You Earn The Money

Throughout the year, a portion of an employee's salary is often set aside to cover their income tax obligations. That is only sometimes the case regarding money from a side business. Putting off paying taxes until the deadline to submit a tax return might result in a significant increase in the tax owed and penalties. By either having taxes withheld from their paychecks or making anticipated payments quarterly, the Internal Revenue Service (IRS) would prefer that taxpayers pay taxes as they earn tax.

If a taxpayer pays at least 90% of their tax bill for the current year via withholding and anticipated payments or pays 100% of their tax bill for the preceding year, they will not be penalized. This applies to the vast majority of taxpayers. Those who succeed in avoiding a penalty will still be required to pay taxes on their overall net income from self-employment.

Ignoring Retirement Savings Options

Saving a portion of the money you generate from a side hustle or other source for your retirement might help make your later years more enjoyable while also lowering the tax of taxes you owe now. A SEP IRA and a solo 401(k) are two retirement plans beneficial for those who work several jobs (k). It is simple to establish a simplified employee pension individual retirement account, which enables individuals to contribute up to 25% of their net income from self-employment, up to a maximum of $57,000 in 2020.

A solo 401(k) has the same limit of $57,000, but it permits contributions of up to 100 percent of the participant's net income from self-employment. Solo 401(k)s need a little more paperwork. Since the contribution maximum is per person rather than per business, it is important to remember that any money contributed to an employer's 401(k) or other retirement plans will count against the limit.

One more piece of advice from McNeill: make sure your side job is worthwhile before you commit too much time to it. After paying taxes and many other expenditures, such as fees to an online freelancing platform, some people find that they are generating less than the minimum wage from their freelance work. Examine what you've finished versus the amount of time required to assess whether or not the additional hours were worth it.