Gig Economy: no doubt you’ve seen these words together in your daily activities on the Internet. There’s a lot that has been written and is being written about the Gig Economy—you’ll find it mentioned everywhere from Forbes to Business Insider to specialty blogs devoted entirely to the subject.
Some of that writing is positive and some negative. We’re not interested in that discussion. We’ll leave debate over its relative merit to someone else, for another time and place.
There are plenty of reasons you might wind up as part of the gig economy yourself, picking up a side hustle away from your day job. You may wish to:
- pay off student loans more quickly,
- pay off any kind of debt more quickly,
- reach financial freedom more quickly, or
- make a hobby into more than a hobby.
Or perhaps you:
- can’t find a full-time job,
- lost a full-time job, or
- have a great idea for a startup.
Whatever your reasons, for the good or bad, here you are: You have a business!
That’s right: You Have A Business.
Your side hustle should be treated like a business, because it is.
The Gig Economy is often associated with Millennials—who, let’s remember, make up today’ 23 to 38-year-olds—but it’s not limited to one generation, helping college kids and retirees make some cash when it’s convenient to them.
OK, for whatever reason or in whatever stage of life, you find yourself with an “extra job” or a patchwork of jobs—what do you need to know?
First of all: Surprise! Those earnings are taxable!
Yes, the income from your “side hustle” and any related expenses must be reported on your tax return. As an independent contractor, you are responsible for paying your own taxes on that income. Let me explain.
How Taxes Work with a Side Hustle
Let’s look at a very popular side hustle: Uber.
You receive your pay from Uber, not from the folks who ride in your car, and Uber reports those earnings on a Form 1099-NEC https://www.irs.gov/pub/irs-pdf/f1099nec.pdf
However, the key point is this: you are not an employee of Uber.
You’ll notice when you get the Form 1099-NEC that there is no tax withheld. That does not mean it’s not taxable; it means that you are responsible for paying the taxes.
You are considered by the IRS to be “self-employed,” and when you’re self-employed, you pay your taxes quite a bit differently than when you’re an employee.
You are taxed on the net income from your business.
What’s NET INCOME?
Net income is your total income from the business less any expenses related to that business. (Related business expenses could be equipment purchased exclusively for business use or, to stick more closely to the Uber example, certain car-related expenses like mileage, maintenance, or repairs.)
This brings up another key point: You must keep good records of your business income and expenses so that you know how much tax to pay. More about that later.
A Little More About Taxes
When you are an employee of a company, you have three kinds of taxes withheld from your check:
- Income Tax
- Social Security Tax
- Medicare Tax
You may never have thought about the fact that there are three taxes; it may not really have mattered to you. Now that you’re self-employed, however, it matters very much—and it can be pretty expensive.
The short of it:
When you’re an employee, your employer withholds social security and Medicare tax from your check. The employer then must match that and send it to the IRS.
When you’re self-employed, you must pay both parts yourself. That’s how this type of income can become expensive very quickly, cutting into your usable income.
In addition, you have to pay your regular income tax on your business income.
The IRS also requires that these taxes be paid in equal, estimated installments throughout the year, usually on the 15th (or the next business day) in January, April, June, and September.
Figuring out when and how to pay those quarterly taxes is usually the point when most folks bring in a professional tax consultant to figure it out, and it’s important to seek help as necessary in a timely manner. There is a penalty for not paying these taxes on time.
There’s more that can be said about taxes, obviously, especially if we want to talk about tax planning. For this short article, however, just know that there are taxes that must be paid on your business income and it’s up to you to calculate it and pay it.
Back to NET INCOME
The only way you can accurately know your net income is by keeping careful records. Most people aren’t too thrilled about record keeping (although some do actually enjoy this!), but that doesn’t matter: when you have a business you must keep records of your income and your expenses.
We used Uber as an example of a side hustle, and Uber helps you out on tracking your income; they do it for you send you a very handy Form 1099-NEC that has it totaled up just after the end of the year.
That’s all well and good, but what if your side hustle is mowing yards or walking dogs—and not through a service like Rover, but on your own?
Likely you just get paid in cash and no one sends you any forms at the end of the year.
CRITICAL NOTE: Cash is reportable to the IRS. My assumption in this article is that no one is not reporting cash transactions, as that is against the law.
You need to track your income whether it’s received as cash, a check, Venmo, PayPal, or some other method. Every type of payment method should be included in your income column.
The best way to track your income is to deposit all of it into a separate business bank account. It can also be incredibly helpful to use a personal finance app like QuickBooks Self-Employed.
About Business Expenses
The IRS is pretty generous in what it allows you to deduct as business expenses, but it requires you to play by the rules.
For instance, if you are an Uber driver as a side hustle, then you obviously use your car, and this is going to be a significant expense. The IRS understands this and they allow you to claim some of those expenses on your taxes, as mentioned above.
However, it’s critical that you keep not just good records, but records exactly as the IRS requires. For example:
You must track your mileage.
Not only must you track it, but you must track it contemporaneously, which means as it’s happening.
You can use an app (there are a number of them out there) or you can use pen and paper to record your mileage. One way or the other, you must keep the records thoroughly.
A question we are often asked is, “What are business expenses? What all can I write off?”
My standard answer is: “Whatever is a business expense.”
It’s not a facetious answer or a non-answer; rather, it’s an accurate answer.
The IRS doesn’t have a list of things that are acceptable expenses. It basically says what I give as my standard answer: you can write off expenses you incur in doing your business. Of course, the IRS uses a lot more words and there are a lot of hoops to jump through, but that’s the essence.
Here’s the deal: for any expense you plan to deduct, you MUST have documentation. If you don’t have documentation, the IRS can (and often does) simply disallow the deduction.
So, back to the Uber gig, what else might be deductible? How about your cell phone?
Basically, your whole business is run through your cell phone, so your cell phone bill is going to qualify as a business expense. But not all of it! Unless you have two cell phones and you use one solely for your business. Most people only have one cell phone, so you would be able to deduct a portion of your cell phone bill.
What portion? Well, you probably need to calculate how many hours a day you to do your Uber side gig and, whatever percentage of your total use that is during one month, record that percentage of your cell phone bill as a business expense.
What does not work with the IRS is to tell them: “I estimate that I use my cell phone 75% of the time for business.” That just won’t fly. Where’s your proof?
What other expenses? How about bottles of water or mints that you have in the car for your passengers?
Sure, those hospitality offerings would be deductible. But many of you might pay cash for those sorts of things, so how do you establish proof of the expense?
You must keep the receipts! You can take pictures of them or scan them and keep them digitally, but you have to keep any and all receipts related to your business expenses.
Every business is going to have its own unique expenses, but what is common is that you must keep records and you must keep receipts.
Additionally, you need to have a system for recording all this information. That system can be sophisticated (an app) or basic (pen and paper), but it must exist. You’re going to need it at tax time and, if you haven’t kept up with this throughout the year, you’re going to spend a lot of unpleasant time sorting through various places (drawers, counters, your glove compartment), trying to pull it all together at tax time.
Organizing as an LLC
Another question we’re routinely asked is, “Should I form an LLC?”
When you have your own business, this is definitely something to consider.
There’s also not a cut-and-dried answer.
Whether you should form an LLC or some other legal entity will largely depend on how much you’re making from your side gig and what your ultimate intent is—do you plan just to make some quick money and dump the business, or do you perhaps intend to grow it?
The primary reason for forming an LLC is liability protection.
Back to our Uber side gig example: For most of our clients who have done Uber over the years, I wouldn’t suggest an LLC. I would, however, strongly suggest that you fully understand your auto insurance and to what degree you’re covered if some kind of accident happens. Likewise, understand the protection that Uber offers its drivers and riders.
There is no tax benefit to simply forming an LLC.
On the other hand, take the lawn mowing as an example. What if you launch this with no other plan than for it to be some side income. However, six months into it, you’re getting more business than you anticipated and you see the business growing. In fact, you’ve had to hire someone to help you. Now your thoughts become, “This is producing significant income and I need to take it more seriously.”
At that point, forming an LLC should definitely be on the table for discussion.
When you see your business begin to scale, you should also start thinking in terms of the most tax-efficient business structure. For instance, converting your LLC into an S Corporation can drastically lower your taxes in certain situations.
For this article, we’re focusing only on the side hustle. We’re keeping it simple. Just know, if business begins to pop, it’s the time for some more strategic planning that can result in significant tax savings.
Saving for Retirement
Let’s say your side gig is not just to add a little extra money to pay bills each month, but to move you down the road toward financial independence. Maybe you don’t necessarily need the additional income to pay bills—in that case, you should definitely be thinking about putting some of this income aside for retirement.
Say you have a day job and you are participating in your employer’s retirement plan, and you also have a side gig where you are self-employed. It’s quite possible that you could put some of that money into a retirement plan of your own. For instance, you could put some of that many into a:
- SEP – Simplified Employee Pension Plan
- IRA – Individual Retirement Arrangement
- ROTH – a variation on the IRA
Each of these financial arrangements is a tried and true way to build wealth. Don’t neglect to consider them for your nest egg-building purposes.
Is there more that could be said about earning through side gigs? Absolutely.
Books have literally been written on the gig economy. The fact that it exists is a testimony to the vibrant nature of the entrepreneurial spirit in this country.
In our practice, we work closely with entrepreneurs who create businesses. Sometimes, these businesses are the main focus of their working lives, and sometimes they’re a side hustle. Working with folks who embrace the entrepreneurial spirit makes our job exciting! We value the complex questions they bring us; in fact, if you’ve got any questions about your income and the gig economy, you should give us a call at 214-761-8304. We’d love to help you find an answer.
See the full article here: https://drive.google.com/file/d/17cUmMk16zpyHfl_rK9BNoBnyOCLu3-cu/view?usp=sharing
From the desk of David Freeze, CPA/PFS.