The Side Hustle Tax Trap: How the IRS Views Hobbies and Side Gigs for Tax Purposes
Activities such as baking cakes, starting a blog or offering tour guiding services give people a path to making money with their hobbies. But the IRS wants to know about that income.
You generally have to report all income to the IRS, whether it’s from a job, Social Security, unemployment benefits or something else. Income that you make from a hobby is no exception, though it’s treated differently from income you make via a business. Here’s what you need to know, and how to avoid the side hustle tax trap.
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The IRS expects you to report side hustle income
Side hustle money is typically taxable, regardless of whether it comes from a part-time job, short-term gigs or online marketplaces. The IRS states that you must report gig economy income even if it is not reported on a tax form such as a Form 1099 or W-2. Reporting becomes necessary the moment your self-employment earnings exceed $400 for the year (and may be necessary otherwise) and you may owe self-employment taxes as well.
You may end up with a large (and surprising) tax liability, known as the side hustle tax trap. The few rides you drove for Uber or pet sitting jobs you picked up via Rover will be on the IRS’s radar as taxable events. Setting aside some money can make it easier to pay taxes when they are due, which is why you often need to pay quarterly estimated taxes throughout the year. If you aren’t sure how much to pay, you can speak with a tax professional.
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Hobby vs. business: The difference comes down to profit motive
The IRS sees money that you earn from a hobby differently from money you earn from a business: “The biggest difference between the two is that businesses operate to make a profit while hobbies are for pleasure or recreation,” according to the agency.
The IRS adds that you should ask yourself whether your intent was to make a profit, whether you can expect future profit from the activity, how much you earned, whether you depend on the income, whether operations were adjusted to improve profitability and more.
Money that you earn from a hobby generally isn’t subject to self-employment tax. But you also can’t deduct expenses related to your hobby.
The practical steps that help avoid trouble
If you see yourself making money from a hobby for the long run, it often makes sense to separate personal and side hustle finances. You can start with a separate checking account, but if the business starts to take off, you may want to consider forming a business entity and getting a business bank account.
You should also track your income and expenses diligently, so you do not underreport your income, but also so you can deduct business expenses. You will also have to do your own version of tax withholding since an employer won’t do it for you.
Consulting a tax professional can help you avoid some of the most common mistakes people make when turning their hobbies into profitable side hustles. They can walk you through all of the necessary forms and help you verify which expenses can be deducted.