Filing requirements based on your side hustle’s legal organization

If you organized your side hustle as a sole proprietorship or a single-member limited liability company (LLC), I have good news for you: Your U.S. federal tax filings for your business will be just another section of your personal taxes on your Form 1040. You don’t have to file any separate returns, at least at the federal level. You will, however, need to file an additional form — a Schedule C — that is basically an attachment to the rest of your personal tax return (see “Keeping the feds happy,” later in this chapter).

What if you set up your side hustle as an S corporation or a partnership? Or what if you set up an LLC with a partner? Great news … if you enjoy more paperwork. In addition to your personal tax return, you’ll need to file a separate return, not just an additional form attached to your personal tax return. Depending on how you structured your business, you need to file either:

• Form 1065 if your side hustle is organized as a partnership or a multi-member LLC
• Form 1120-S if your side hustle is organized as an S corporation

Don’t worry, your Form 1040 for your personal tax return won’t feel left out if your side hustle financials show up on either a Form 1065 or a Form 1120-S. Technically, you don’t pay taxes on either S corporation or partnership income — at least not directly. If you used either of those legal structures for your side hustle, your business income (or loss) will pass through to your Form 1040, where you’ll mash all those details together with income from your day job, your personal deductions, and the rest of your personal tax stuff. You use an IRS form called a K-1 to carry your side hustle corporate or partnership finances over to your personal return. (You’ll have slightly different versions of a K-1 depending on whether your side hustle is an S corporation, a partnership, or a multi-member LLC.)

The more complicated your side hustle’s legal structure is, the more complex your tax filing requirements will be — basically, you have a straight-line relationship up the complexity ladder. But I step you through the highlights in the “Filing Your Side-Hustle Income Taxes” section later in this chapter.

Here’s a little bit of good news: If your side hustle is one of those where you’re paid as a part-time employee rather than as an independent contractor — say, teaching a class or two at the local community college — then you’ll receive an IRS Form W-2 for each tax year, the same as you get from your full-time employer. In that case, all you need to do for your taxes is treat your side hustle just like it’s another job and add your side hustle income to your regular income.

Tax rules and forms depending on your specific side hustle

If your side hustle is service-oriented and you aren’t dealing with any physical inventory, your tax returns won’t be all that complicated, even if you did set yourself up as an S corporation or a partnership. If, however, you’re running an online store where you need to keep track of your cost of goods sold (see Chapter 8) and the value of your inventory, then not only is your overall side hustle record-keeping more complicated, but your taxes may turn into a head-scratcher, too.

Remember this simple equation: The more physical items you have that play any sort of a role in your side hustle, the more complicated your taxes will be. If you’re buying goods to resell, or if you need to purchase shelving and containers to hold products, then your taxes will be more complicated than if you’re recording and uploading videos, or doing software work, or doing ridesharing for Uber or Lyft.

Everyone wants a piece of the tax action

If you live in the United States, you’re well aware of the Internal Revenue Service (IRS). If you live outside the United States, then you need to file tax returns with the equivalent of the IRS in your country.

You don’t only have to pay up and file returns with the feds, however. Your state and maybe even your city want their cut of your side-hustle profits, and you’ll need to file the proper returns along with writing the checks or doing the electronic funds transfers to pay the taxes that you’ll owe.

As complicated as the federal side of taxes can be, in many cases the state and local side is even more complicated. Why?

• If you’re doing your side hustle in Arizona, you’ll file different state tax return forms than if you’re side hustling in Pennsylvania or California or any other state.
• Some states just wants a copy of your federal return, but others have their own sets of forms. And to complicate matters even further, many states allow different deductions for expenses than the feds do, meaning that the net income from your side hustle for tax purposes may be different for the IRS than it is for the state where you live.
• Some cities get in on the act also, and you have to file yet another set of tax returns — and shell out even more money — to the city where you live and where you’re side hustling. Or maybe you’re getting hit at the county level rather than the city level. Sometimes those local taxes are only on W-2 wages (basically, the money you make from your day job), but in other cases, they’re full-blown tax returns that apply to side hustles.

Decision time

You have two paths you can take when it comes to your side-hustle taxes and filing your returns:

• Do it yourself.
• Hire an accountant.

Even if you decide that you want to do your own taxes, you don’t have to study up on a ton of tax laws that are always changing or do a whole lot of calculations by hand. All the big tax-filing programs such as Credit Karma Taxes, TaxSlayer, TurboTax, and many others will step you through not only your personal taxes but also basic small-business taxes that would apply to your side hustle, no matter how you set up your business (sole proprietorship, partnership, S corporation), even if your side hustle is just another part-time job with a regular old W-2.

And speaking of small-business taxes: You don’t need to be an expert in taxes for your side hustle. After all, you have dozens or even hundreds of other tasks to take care of or decisions to make. However, you should still have a basic idea of the big picture, tax-wise, for your side hustle. Beyond the basics I cover in this chapter, you can also check out Small Business Taxes For Dummies, 3rd Edition, by Eric Tyson (Wiley).

Even if you made the command decision to hire an accountant to file the tax returns related to your side hustle, you still need to pay attention to some key points and beware of a few big-time traps that could really trip up you and your side hustle. Specifically:

• Avoid the temptation to use your side hustle to “get creative” with your tax returns.
• Be aware that if your side hustle crosses state lines, your tax picture could get murky and complicated.
• Remember that tax laws change frequently and can be tricky.
• Be sure to correct any tax-related mistakes that you make.

Business deductions for your side hustle

Suppose your side hustle is an online retail site, where you buy clothing items from wholesalers that you then list and sell. While you’re buying clothing items for your business, why not buy some for yourself that you can “hide” among your business purchases? Then you can deduct all that clothing, and basically get your jeans and shirts and shoes at a 30 percent or 35 percent discount because you’ll owe less in federal and state taxes.

Don’t do it!

Maybe you do a little bit of traveling for your side hustle, and you deduct all those travel-related expenses. You know what? Why not deduct the costs of your next family vacation as well? You already have a bunch of legitimate tax deductions for airfare, hotels, meals, and other travel expenses, so who would ever know if you added a few more travel expenses that really shouldn’t be on your side hustle’s tax return?

Don’t do it!

Suppose you send a lot of packages to your customers via FedEx, UPS, and the U.S. Postal Service (USPS). Everything that you spend on packing materials and shipping costs is deductible. Why not also include the cost of shipping about a dozen packages to your out-of-town friends and family members for the holidays?

Don’t do it!

Even if you’re not swayed by the morality and ethics of cheating the government by lying — yeah, I said lying! — on your tax returns, how about a practical reason to be honest when it comes to your side hustle’s taxes? If you get caught, you’ll be in big trouble! At best, you’ll owe money — maybe a lot of money! — for back taxes, interest, and (most likely) penalties. At worst, the government could decide to criminally charge you with tax fraud. Even if you escape being convicted, you’ll have to spend a ton of money on attorneys’ fees.

Will the government really come after you for claiming $100 in shipping expenses that you shouldn’t have, or for “only” $2,000 in personal travel that you inaccurately claimed as a legitimate business expense? Maybe not — but do you really want to take the chance?

Taking your side hustle across state lines

Even if you’re determined to be 100 percent honest when it comes to your business taxes, you still need to be aware of several complications that could affect you, depending on what you do for your side hustle.

How would you like to be treated like a professional athlete? Well, maybe you can’t dunk a basketball or hit a 100-mile-per-hour fastball or score a game-winning field goal. But you can pay taxes to a bunch of different states just like the pros!

The so-called jock tax, sometimes referred to as the Michael Jordan Rule after the legendary basketball player, came into existence in the early 1990s. Jordan’s Chicago Bulls defeated the Los Angeles Lakers in 1991 to win the National Basketball Association (NBA) title. According to legend, the folks in California decided to get a little bit of revenge by declaring that because Jordan “worked part-time” in California — that is, he played professional basketball games each season in the state — technically he should owe California state taxes on the portion of his income earned there.

Before long, many states had versions of California’s law governing out-of-state athletes playing professional games within their borders, and those pro athletes found themselves (or, more accurately, found their accountants) filing tax returns in a bunch of different states each year.

So, what does all this jock tax stuff have to do with side hustles? If your side hustle is, say, doing some consulting work that involves travel to a different state, you could find yourself subject to the same paying-some-other-state tax laws as Michael Jordan or almost every other professional athlete. Even though my personal experience with the non-athlete’s equivalent of the jock tax came from my full-time consulting days rather than from one of my side hustles, I’ve seen and dealt with this complicated tax picture first-hand.

If your side hustle doesn’t cross state lines, then (in the spirit of where the so-called jock tax began) “no harm, no foul.” In other words, you won’t be impacted at all. But just be aware that if your side hustle grows to the point where you do wind up “working” in another state, you need to check up on any nonresident tax rules that may apply to you. Even if your home state has a reciprocal agreement with another state to help their residents avoid out-of-state taxes, very often the reciprocal agreements only apply to regular salaried wages, not self-employment income — which is where your side-hustle income usually sits.

Now for your next side-hustle tax trick …

Your full-time employer sends you a W-2 tax form that shows you how much you earned in salaries, bonuses, and other taxable income. You then use the numbers from that W-2, or give the form to your accountant, as the foundation for the income portions of your personal tax return. If you had more than one job during the year, you’ll have multiple W-2s that you combine onto the “Wages, Salaries, Tips, etc.” line near the top of your tax return.

What about your side-hustle income? Unless your side hustle is something like part-time teaching, where you’ll receive a W-2 because you’re technically an employee of a university or community college, you won’t receive any W-2s for your side-hustle income. Instead, you may receive a Form 1099-MISC and/or a Form 1099-NEC.

The IRS added the 1099-NEC in 2020, splitting out many side-hustle payments from those that previously were reported on the 1099-MISC onto this new form. “NEC” stands for nonemployee compensation, which means exactly that: compensation paid by a company or an individual to someone who is not an employee, but rather an independent contractor. If you pay rent or make attorney payments for your side hustle, you still use the 1099-MISC to report those payments.

Beginning in 2018 and thanks to tax-law changes in the United States called the Tax Cuts and Jobs Act, some nonemployee compensation and other income got even more complicated when it came to tax season. This time, however, the complications were actually good for tax filers, including many side hustlers.

In the past, if you earned $50,000 from your side hustle after deducting all your expenses, you would be taxed on that full $50,000 in addition to your full-time salary, interest, dividends, and all the usual taxable items in any given tax year. Now, thanks to the 2018 tax law, you’re allowed to deduct up to 20 percent of your side-hustle income before you start figuring out your taxes. So, that $50,000 that used to be fully taxable gets magically changed into $40,000 by deducting $10,000 (20 percent) before you do your tax calculations.

The Tax Cuts and Jobs Act (TCJA) is actually more complex than the simple math shown here. First, your side hustle needs to be structured as one of the following pass-through entities:

• A sole proprietorship
• A partnership
• An S corporation
• A limited liability company (LLC)

Well, guess what? Take a look at Chapter 7 and your options for setting up the legal structure of your side hustle. Let’s see: a sole proprietorship … a partnership … an S corporation … an LLC. Four for four! So, in almost all cases, your side hustle will have passed the first test to take advantage of that wonderful 20 percent deduction.

Then you’re allowed to take the 20 percent deduction on what the IRS calls qualified business income (QBI). QBI is actual income from your small business operations. So, you wouldn’t include dividends, capital gains, or other non-operations income. Most likely, though, a small business that is your side hustle wouldn’t really have any of those other income streams anyway, so you should be in good shape.

The TCJA law has a lot of other technicalities that you really don’t need to worry about, because either your tax software or your accountant will take care of walking through the complications and rules for you.

You should, however, know that this bonus 20 percent deduction on pass-through qualified business income may not last forever. Lots of folks aren’t too happy about businesses getting a lot of tax breaks that became effective in the United States in 2018, even small businesses — including side hustles. Tax laws change frequently, so don’t be surprised to see the TCJA 20 percent deduction going away at some point in the future. Take advantage of those extra tax savings while you can!

Uh-oh — you goofed!

Your side hustle taxes can get really complicated. Even though you try to be as accurate as possible, sometimes you make a mistake.

If your side hustle is set up as either an S corporation (where you file a Form 1120-S) or a partnership (where you file a Form 1065), your filing deadline is not the same as the normal April 15 due date for your personal taxes. You actually need to get all your separate side hustle business tax filings done a whole month earlier, on March 15 of each year. Even if you file for an automatic extension as you can do for your personal taxes, you don’t have until October 15 to belatedly get your S corporation or partnership taxes done. You need to take care of those extended filings by September 15 of each year.

So, did you forget to file your side-hustle business taxes on time back in March? And did you also forget to file an extension? Or did you forget to include some of your side-hustle income or accidentally enter the wrong number for an expense? Maybe you made a mistake the other way around: you double-counted some of your side hustle income or forgot to include some legitimate business expenses, and wound up paying more in taxes than you actually should have.

If you discover after you filed a tax return that you made a mistake, file an amended return as soon as you can. If you’ll owe more in taxes than you actually paid, the sooner you file the amended return, the less you’ll have to pay in interest and penalties.

Likewise, if you forgot to file a return by a deadline, get that form in as soon as you can to cut down on the amount you’ll have to pay in interest and penalties — not to mention avoiding potential legal issues for not filing your taxes.

Keeping the feds happy

If you organized your side hustle as a sole proprietorship or single-member LLC, you attach a Schedule C (see Figure 10-1) to your personal tax return and your Form 1040. Schedule C includes all the tax information for your side hustle for the previous year. You can download the current Schedule C at www.irs.gov/pub/irs-pdf/f1040sc.pdf.

If you filed for and obtained an employee identification number (EIN) for your side hustle, you need to show both your personal Social Security number (SSN) and your EIN on your Schedule C (refer to Figure 10-1). The IRS separates your tax return into various forms, schedules, and attachments before it does its processing, so this way it can keep track of not only your side hustle (via your EIN) but which individual is actually running that side-hustle business.

You also need to enter what your side-hustle business is (for example, online retail or book editing) onto your Schedule C, along with a standard business activity code that identifies your business (refer to Figure 10-1). The IRS can periodically change those business activity codes, so make sure that you always check each year to make sure you’re using the correct code. You can find them at www.irs.gov/pub/irs-pdf/i1040sc.pdf.

Line G on Schedule C (refer to Figure 10-1) asks, “Did you ‘materially participate’ in the operation of this business during [the tax year]?” Basically, the IRS is asking you: “Is this a real business, or are you just trying to take a bunch of deductions?” You don’t want to lie, but you really want to check the “Yes” box to indicate that you’re actively involved in your business, even if you wound up losing money. If you have any doubts about whether your side hustle qualifies as “material participation,” check with an accountant!

What if you set your side hustle up as an S corporation? You have to file a separate tax return, right? Figure 10-2 shows Form 1120-S, which you need to file if you organized your side hustle as an S corporation. You can download the form at www.irs.gov/pub/irs-pdf/f1120s.pdf.

Suppose you sold $10,000 worth of products last year, and you spent $2,000 to buy those products. You’ll do the simple math on your 1120-S to come up with $8,000 of total income. Easy, right?

Notice, though, that on Form 1120-S, you enter your side hustle’s EIN, but not your personal SSN. You also don’t directly pay taxes when you file a Form 1120-S. Instead, that information needs to get attached to your personal return. But how does the IRS know that the Form 1120-S is for you, when your SSN isn’t anywhere on your business tax return?

Figure 10-3 shows a Schedule K-1 that your side-hustle business will issue to you as an individual. Yeah, that sounds a bit formal for a side hustle, but that’s how the IRS keeps all the money stuff straight. Notice that the Schedule K-1 has both your side-hustle EIN and the rest of your side-hustle basic information (company name, business address, and so on), as well as your personal SSN and your personal information. You can download Schedule K-1 at www.irs.gov/pub/irs-pdf/f1065sk1.pdf.

Suppose you file your business taxes on March 15. When you file your personal taxes a month later, you’ll attach Schedule K-1 to the rest of your personal tax return and enter your net business income onto a Schedule E on your personal tax return (see Figure 10-4) to make sure that you do your tax calculations correctly. You can download Schedule E at www.irs.gov/pub/irs-pdf/f1040se.pdf.

Your Schedule E will contain your personal SSN (refer to Figure 10-4), which the IRS uses to link all this tax data to you personally. You also indicate the official business name of your side hustle and that you set your business up as an S corporation, along with your side hustle’s EIN (refer to Figure 10-4). Presto! The IRS now has all your side-hustle S corporation information and your personal information, all linked together, including your business income (refer to Figure 10-4), which you pull from your Schedule K-1 (refer to Figure 10-3).

If your side hustle is organized as an S corporation, you will not receive 1099-MISC or 1099-NEC forms from businesses that provide you with your side-hustle income! The IRS rules state that 1099s do not need to be sent to S corporations. So, you can’t calculate your side-hustle business revenue by just adding up all the amounts on 1099s that you receive at the end of the year, the same as you do for your W-2s and personal 1099s (interest, dividends, royalties, and so on) for your personal taxes. So, how do you know how much money you took in? Through your business records, of course! See Chapter 9 for the inside scoop on keeping track of everything that goes on in your business, including your income and expenses.

If you and one or more partners legally organized your business as a partnership, you’ll file Form 1065 (shown in Figure 10-5). You can download Form 1065 at www.irs.gov/pub/irs-pdf/f1065.pdf.

Suppose you and one other person went in together on a side hustle. You would enter the number 2 on the line that says, “Number of Schedules K-1. Attach one for each person who was a partner at any time during the tax year” (refer to Figure 10-5). Just like your K-1 from an S corporation, you would receive a K-1 from your partnership — and so would your one partner in this case, because you indicated on the form that two K-1s were attached, meaning that your side hustle is made up of two partners.

Your state wants their cut, too

Even if you live in a state that doesn’t have a personal income tax, you probably have to file business taxes for your side hustle. After all, your side hustle may be a small business, but it’s still a business!

Every state has its own laws and peculiarities. If you do your own taxes, your tax software will step you through your state filings after you’re done with your federal returns. If you hand all your tax-filing stuff over to an accountant, they’ll take care of the state side for you as well — including any cross-state filing requirements that may apply (see “Taking your side hustle across state lines,” earlier in this chapter).

Keeping your tax money local

If you live in a city that requires you to file a local income-tax return, you may owe money on your side-hustle income. Some cities, though, only tax wages — basically, your salary — so if you’re running a business for your side hustle rather than receiving a W-2 for, say, teaching college courses on the side, you may not owe any additional taxes or have to worry about filing a return. Check with your accountant or make sure that your tax software takes care of figuring out your city taxes as well.