Freelancing and participating in the gig economy is a fantastic way to bring in a little extra fun money, to accelerate debt payments, and to help you save for a big financial goal. Perhaps you’ve already started a side hustle in the hopes of being your own boss one day. In either case, thinking of yourself like a business is more advantageous come tax time.
With that in mind, here are some tax considerations for the gig economy as well as some tax planning moves to make before the end of the year.
Know the nature of your business
First, you’ll want to evaluate whether driving for Uber, selling essential oils, or freelancing is a business or hobby since that impacts how your income is taxed and whether you can deduct any losses. Spoiler alert: it’s better to be a business because you can offset income with deductible business expenses. Unfortunately, the ability to deduct hobby expenses has been eliminated since those were reported under the now-defunct miscellaneous itemized deductions.
In the eyes of the IRS, an activity could be a business or just a hobby depending on how you treat it. For example, the IRS “presumes that an activity is carried on for profit (i.e., it’s a business) if it makes a profit during at least three of the last five tax years, including the current year.”
If you’re unsure how to categorize your business, a CPA or tax preparer may be able to help you. If your side hustle is clearly a business, then taking these steps now can minimize stress when April rolls around.
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Lower your taxable income
In 2018, it may be more important than ever to protect your side gig’s net income before the end of the year. The Tax Cuts and Job Act of 2017 (TCJA) created a new Qualified Business Income (QBI) deduction for pass-through entities (i.e., partnerships, S Corporations, and sole proprietorships). These businesses are generally allowed a deduction equal to the lesser of:
- 20% of QBI (not including net capital gains) or
- 50% of W-2 wages paid by the partnership, S corporation, or sole proprietorship.
This deduction is based on your combined taxable income and whether the business is a “specified service trade or business.” The full 20% of QBI deduction applies to single individuals who earn $157,500 or less or married couples filing jointly earning $315,000 or less. Once you are over the threshold, the deduction may be limited as it takes into account wages paid by the business, qualified property, and whether you operate a specified service-based business (i.e. attorney, accountant, doctors, etc.).
Work with your CPA now to calculate whether your business is eligible for the deduction and if there’s any way to lower your taxable income to below the threshold, in order to take advantage of the full 20% deduction. Keep in mind, this deduction only impacts your income tax calculation, and 100% of QBI for sole proprietors and partnerships is still subject to self-employment taxes.
Spend if you need to
When it comes to tax planning, many business owners think only about increasing year-end business spending to lower their taxable income. While some purchases like a new laptop or conference tickets may be truly needed to move your business forward, it’s not a dollar for dollar benefit on your ending tax bill. If you’re in the 24% tax bracket, spending $100 will only save you $24 in taxes. So is it better to spend the net $76? Or keep $76 in your pocket?
Contribute to retirement accounts
On the other hand, contributing to a small business retirement account or HSA is a fantastic way to lower taxable income and save for the future. Contributing to a traditional IRA is a great place to start. A Roth IRA is also a good option, but contributions are made with after-tax dollars, so you won’t save on taxes today.
If you have more than $5,500 to save and have self-employment income, consult with a financial advisor about whether opening a SEP IRA, SIMPLE IRA, or Solo 401(k) is the best fit for you.
Improve your skills
Spending on professional development may also be another great way to lower your taxable income while improving your business skills.
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Prep now for tax time
Rather than scrambling in the spring, take a few hours right now to catch up on your bookkeeping. Knowing your business’s net income or loss will help you determine whether you should pay any estimated taxes or possibly change your income tax withholdings at your day job. If you don’t have a separate business account, comb through your bank and credit card statements and tally up your business income and expenses — and consider opening a separate bank account and credit card exclusive to your business for next year.
Track your mileage
If you drive for work, be sure to pull together a mileage log or use an app like MileIQ. As an Uber or Lyft driver, their app will track some of your business miles, but there are additional ones like driving to a busy area in the hopes of picking up a passenger before logging into the ridesharing app. With a standard mileage rate of 54.5 cents per business mile in 2018, every little bit helps!
Even if your side job isn’t driving, your work-related miles could be tax-deductible.
If you have a dedicated home office space, you’ll be eligible for the home office tax deduction. There are two ways to calculate the home office deduction:
- The simplified method is generally calculated by taking the area of your home used for a qualified business use and multiplying by $5. The area you use to figure your deduction is limited to 300 square feet. So, the maximum you can deduct is $1,500.
- Or you can total your actual expenses (rent, mortgage interest, repairs, property taxes, etc.) and multiply those by the percentage of your home devoted to business use.
Home-based business expenses
There are other expenses, like your cell phone or home internet, that have a split business and personal use. Tally up your total expenses and then calculate the portion that actually relates to your business. For example, if you use your home internet 25% of the time as a freelance writer, 25% of your internet bill could be eligible as a deductible business expense.
Consider hiring a pro
If all of this sounds a little overwhelming, now is the perfect time to start interviewing CPAs and tax preparers. Things get busy for them starting in January, so they may not have the time or capacity to talk to you about becoming a new client if you wait too long. And if you haven’t touched your bookkeeping since last year, I recommend finding an accountant or bookkeeper to help organize your business finances. Doing this now will prevent some headaches while also helping to maximize your business deductions.
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Cathy Derus is the founder of Brightwater Accounting. As a CPA and financial planner, she helps individuals and business owners eliminate stress and worry over taxes, business finances, and more. Anyone can throw numbers into tax software. She’s here to help you make sense of those numbers and create a better financial strategy for your business and life. Her expertise has been featured in Entrepreneur, CNBC, US News & World Report, The Washington Post, Real Simple, and Cosmopolitan.
Haven Life Insurance Agency does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.