According to recent polls, about one in three American workers now participate in the gig economy.
A side gig creates an additional income source, reduces your dependence on your employer, and enables you to build new skills.
But it’s important to consider how your income from side gigs might be impacting your income taxes, and how to maximize your eligible tax deductions.
You will likely have to pay self-employment taxes
When you operate side gig, the IRS treats you as self-employed, which means you will have to pay twice the FICA taxes (commonly known as self-employment taxes).
FICA taxes include Medicare and Social Security taxes, for which the employees are required to pay 7.65%.
In reality, an employer is covering the other half of these taxes. As a side gig owner, you will have to pay the total FICA tax bill on your own, which comes to 15.3% currently.
Your income tax return is going to be more complex
The income tax return is fairly straightforward for those who just receive an income from a W-2 job.
But with a side gig, your tax filing is going to get cumbersome because you become a self-employed. You will be required to send 1099s to people you paid.
You should be prepared to keep a record of every business-related expense so that you can take a tax deduction, and then defend it in an IRS audit.
Tax returns with a side gig will become longer because you will fill out Schedule C as a sole proprietor to document those business related expenses.
You should file estimated taxes every quarter
When you are an employee, your employer will take out estimated taxes from your paycheck and make the payment on your behalf to the IRS throughout the year.
When you are engaged in a side gig of your own you will have to do this exercise on your own, provided you owe at least $1,000 in self-employment taxes.
You will have to prepay the estimated taxes on a quarterly basis. When you file your annual return, you may either receive a refund or may have to pay additionally to cover any deficit in tax payment based on your actual final income.
Be prepared to maximize side gig expense deductions
If you are operating a side gig as a self-employed individual, you will be able to deduct certain expenses that employees generally cannot.
For instance, if you work from home, you are allowed to deduct a portion of your housing costs.
From paper, stationery, and data plans to purchases such as a tablet or laptop, you should be able to get at least a partial deduction for these expenses under IRS Section 179.
Check if you qualify for the pass-through deduction
As a side gig operator, online business owner, or a freelancer, if you have structured your business as a pass-through legal entity (such as an S corporation or an LLC), chances are that you would be eligible for the 20% pass-through deduction.
This means you can deduct one-fifth of your side gig income before adding it to your other incomes for tax computation.