Today, many people have a sideline business to make extra money, to test a business concept, or to just enjoy a different type of work. The gig economy, where self-employed individuals find freelance and other business opportunities through such online platforms as Uber, TaskRabbit and Upwork, is proving to be a good avenue for sideline businesses. But sideline businesses can be independent of any such platform. If you have a sideline business, or are thinking of starting one, make sure to understand the tax implications of your activity.
Tips on Side Business Taxes
Report All Income
There is no income threshold or minimum amount you have to earn in order to report income; all of it is reportable. Depending on your sideline, you may receive an information return reporting your income, which also alerts the IRS to the income:
Form 1099-MISC reports payments to independent contractors.
Form 1099-K reports merchant transactions (gross amounts processed on credit cards, etc.). You don’t have to reconcile the amount on the 1099-K with the gross receipts reported on your tax return because the information doesn’t take into account chargebacks and other adjustments to sales income.
Pay Self-employment Tax on Profits
If your business is unincorporated and is profitable, your net earnings are subject to self-employment tax to cover your obligation or Social Security and Medicare taxes. While you won’t owe the portion for Social Security tax if your net earnings from self-employment plus any wages are below the annual Social Security wage base ceiling ($127,200 in 2017), you’ll owe the Medicare portion of self-employment tax because there’s no wage base ceiling here.
Remember that one half of self-employment tax is deductible from gross income on Form 1040 (no itemizing is required).
Cover Estimated Taxes
If your sideline business is unincorporated, there’s no withholding on your earnings. It’s up to you to pay your income taxes and self-employment taxes throughout the year through quarterly estimated tax payments. However, if you also have a job, consider adjusting your withholding to cover the taxes related to your sideline business. Alternatively, if you have a spouse with a job and plan to file a joint return, ask your spouse to adjust his/her withholding to cover the taxes related to your sideline business.
Add to Retirement Savings
If you show a profit in your sideline business, you can cut your taxes and save for retirement by contributing to a qualified retirement plan for this activity. For example, you can set up a Simplified Employee Pension (SEP) for your unincorporated business and contribute up to 20 percent of your net earnings (up to a maximum of $54,000 in 2017). The contribution is tax deductible, reducing the amount of profits you effectively pay tax on. And you’ll increase the size of your retirement nest egg.
Watch Out for Losses
If you have a loss for the year because your expenses exceed your sideline business income, understand that the losses are deductible as a business loss only if you’re in the activity to make a profit. Without a profit motive, the IRS may claim the activity is a hobby. This means income must be reported but expenses (the loss) are allowed only up to the amount of income, and must be claimed as a miscellaneous itemized deduction. This means you have to itemize to take the write-off, and only the total amount exceeding 2 percent of your adjusted gross income is deductible.
The IRS has a landing page for the Sharing Economy. Here you’ll find links to the issues I’ve discussed, and more.