If you’re working in the gig economy, you may not be setting aside enough to pay your taxes. This is especially true if you’re used to working as an employee, receiving a W-2 and paying your taxes once a year. As a Lyft driver, a food delivery person or an AirBnB host, you’re probably classified as an independent contractor. That means receiving a 1099 and paying estimated taxes on a quarterly basis.
Even if you’re an employee who receives a W-2, you may still end up owing a substantial amount at the end of the year. That’s because it’s common to under-withhold on second jobs. It’s important to take all your earned income into account when filling out your W-4 for each job.
A recent survey found that over a quarter of Americans are earning cash from a side job — and not declaring it. That’s some 69.8 million people failing to report around $214.6 billion. The IRS is undoubtedly aware — especially because the most common income bracket to be earning money on the side is the one between $150,000 and $300,000.
With billions of dollars going unreported by earners, the IRS may see those earning $150,000 to $300,000 as a tempting target for audits. The average earned annually on side jobs is about $3,080, which is not insignificant for most people. The last thing you need is to find out you owe taxes on that full amount — plus penalties and interest.
What do I need to do?
If you’re working as an independent contractor, you’re running a business. You need to carefully track your income and business expenses. People who have spent most of their careers in traditional employment relationships may be unfamiliar with how this is done.
Even though you want to start saving your receipts, you don’t want to save every piece of paper you receive. You’ll need to keep track of your work orders and invoices, for example, but not every receipt from a fast food lunch. (Unless you’re traveling for business or entertaining clients, you generally can’t deduct the cost of your meals.)
What’s deductible? The IRS allows you to deduct expenses that are ordinary and necessary for running your business. A simple list of commonly deductible expenses might include:
- Advertising, including web hosting
- Continuing education costs
- Ordinary supplies
- Business cards and letterhead
- Expenses associated with a space in the home used routinely and exclusively as an office
- Capital expenses for certain office equipment (requires a calculation of depreciation)
- A percentage of client entertainment and meals
- A percentage of car expenses or the standard mileage rate for ordinary business travel
In order to deduct these expenses, you need to know how much you spent and on what. That’s why you need to save your receipts — and not in a shoebox. You don’t want to end up with a big box of undifferentiated receipts to sort through at the end of the quarter.
While you remember what each receipt was for, write it down. Buy yourself good business software and routinely entering your receipts into the program, or work with a bookkeeper. The most important way to avoid headaches at tax time is to avoid procrastination.
Also, a provision in the new tax law gives sole proprietors and owners of pass-through entities to deduct 20 percent of their business revenue from their taxable income. For many more affluent couples substantial AirBnB income, that could save around $15,000 annually. Your own tax savings may vary.
A few final notes: Before you even begin a side gig, you should make sure your current employer doesn’t prohibit outside work. Assuming they do not, be careful about mixing deductions that relate to your side job with those from your main job — and never try to deduct items provided by your employer.