This Silly Side Hustle Mistake Could Cost You Big Time

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Don't fall into this common trap.

Key points

  • Many people with a side hustle get paid on a freelance basis.
  • That could result in a tax headache, especially if you don't pay taxes as you go.

There are plenty of good reasons to get a side hustle. Not only might that extra income help you boost your savings or pay off debt, but it could make it possible to do more fun things like attend concerts and go on vacation.

Now there are different types of side hustles you can get. You may decide to pick up shifts at a local store, in which case you'll generally receive a paycheck with taxes taken out of your earnings from the start. But if you're paid for your side hustle on a freelance basis, you won't have taxes taken out of your pay. If you don't set money aside for taxes as you earn it, you could run into trouble with the IRS.

You need to pay taxes as you go

When you earn money, the IRS likes to get its share as soon as possible. That's why salaried workers have taxes deducted from their incomes each pay period, as opposed to not having taxes removed and settling up with the IRS at the end of the year.

Similarly, if you earn money on a freelance basis (which a lot of side hustle work entails), you're technically supposed to pay the IRS its share as you go. If you don't, you could wind up with penalties for underpaying your taxes.

The IRS charges underpayment penalties when filers don't contribute enough toward their tax obligations during the year. Now there are ways to avoid those penalties -- namely by:

  • Paying 90% or more of your current tax bill
  • Paying 100% or more of your previous year's tax bill
  • Owing less than $1,000 in an underpayment

Let's say you paid the IRS a total of $10,000 in taxes for 2020. Let's also say you worked a side hustle in 2021 you didn't pay taxes on, and you now owe the IRS $10,500 in taxes for 2021.

If you paid the IRS $10,000 in taxes in 2021, you'll avoid being penalized for an underpayment. That's because you'll have paid at least 90% of your current tax bill, you'll have paid 100% of last year's bill, and you owe under $1,000.

Keep in mind you don't have to satisfy all of the criteria above to avoid an underpayment penalty. You can satisfy one of those requirements and get out of being penalized.

The point, however, is you're required to pay taxes on all side hustle income. And even if you don't get slapped with an underpayment penalty, you'll still need to come up with that money by the tax-filing deadline. So in our example, if your side hustle made it so you owe the IRS $10,500 in taxes for 2021, but you only paid $10,000, you still have a $500 tax obligation -- penalties or not.

Set money aside for taxes

It's important to set money aside from your side hustle earnings to cover your tax obligation on that income. There are online tools you can use to calculate your tax obligation, but you may want to consult with an accountant if your side hustle income is substantial.

There are different factors that go into calculating your total tax bill, like how much money you make from investments as one example. A professional can help you figure out how much money from your side hustle to allocate to the IRS.

Furthermore, if your side hustle pays a lot, it's a good idea to send the IRS some money every quarter to avoid an underpayment penalty. This practice is common among full-time freelancers, but it's a good thing to do if your side hustle earnings are substantial and you don't have taxes taken out of them from the start.

Estimated tax payments for side hustle income you earn in 2022 are due on:

  • April 18
  • June 15
  • Sept. 15
  • Jan. 17, 2023

Don't get caught off-guard

The IRS has a way of getting its hands on all sorts of income you earn, whether it's your wages from your main job, your side hustle income, or the minor amount of interest your savings account pays you. If you have a side hustle that pays you on a freelance basis, be sure to set money aside for taxes along the way and possibly send it to the IRS every quarter. Otherwise, you might really end up with a hassle when your tax return comes due, and you could end up facing costly penalties that may have otherwise been avoidable.

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