Working a side gig might be a financial necessity for some people, a passion project for others. Whatever the reason for working more than one job, it’s important to understand the impact the extra income can have on taxes.
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From freelance consultants to NIL athletes, any kind of self-employment comes with a different set of rules than a standard W-2 paycheck. It’s easy to assume it’s a case of paying more income tax, but the reality isn’t that simple.
The Double-Sided Tax Bill
In a traditional W-2 job, the employer pays half of the Social Security and Medicare taxes while the employee pays the rest. So what happens when there’s no employer?
Sherman Standberry, certified public accountant (CPA) and CEO at My CPA Coach, explained that “in addition to federal and state ordinary income tax rates, self-employment tax is a 15.3% tax assessed on self-employment income.”
This applies to net earnings up to a limit, which the IRS clarifies as 12.4% for Social Security and 2.9% for Medicare taxes.
In a recent YouTube video, Standberry shared that reclassifying self-employment income by forming an S Corporation, for example, can minimize liability. More casual side hustlers like dog walkers, rideshare drivers or gig workers, however, won’t see much benefit from that approach.
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Pushing Into Higher Tax Brackets
Extra income from a side gig adds to someone’s total taxable income, so could potentially push them into a higher marginal tax bracket. While the higher rate is only paid on the amount in the new tax bracket, it means the extra money earned can feel much smaller than expected.
Losing Credits or Deductions
Extra income can quietly shrink tax breaks. Credits like the Child Tax Credit or education benefits reduce gradually as income rises, meaning earning “a few extra dollars” could leave less money overall, per the Tax Policy Center.
Strategies To Keep More Cash
Staying ahead of the tax bill involves more than just saving money in a side account. It requires active management throughout the year.
“Individuals need to understand the tax consequences of the type of income they earn,” Standberry said. “And they should make estimated tax payments throughout the year to avoid surprise tax bills in the future.”
Beyond payments, maximizing deductions is essential. Unlike W-2 employees, those with side businesses can often write off ordinary and necessary expenses like equipment or professional software.
Audit Risk
Failing to report side income or inflating deductions increases the chance of an IRS audit. David A. Perez, enrolled agent and CEO of Tax Maverick AI, said, “The freelancers who face audits are often those who guess rather than document.”
Keeping meticulous records of every business-related purchase is the best way to lower the total taxable amount. Treating the side hustle like a serious business is the only way to ensure the extra work actually pays off.
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This article originally appeared on GOBankingRates.com: Side Hustle or Second Job? How Extra Income Could Backfire on Your Taxes If You’re Not Careful
