When to Separate Side Fuss From Personal Taxes
We are living in an era of the gig economy, according to a 2019 Bankrate study , as nearly half of Americans make extra money from side deals . But when should you treat your side as normal business and pay taxes separately from your individual tax return?
Knowing When Your Side Hustle Has Turned Into Business
When your side work has become more than just a hobby, it’s time to split your finances. The IRS defines a hobby as an individual pursuit with no purpose of making a profit. This is a vague definition, especially since you can still make money through hobbies (such as selling paintings on Etsy), but the rule of thumb is that if you make a profit after three out of five years, the IRS will most likely consider you to be leading the way. business. Other issues the IRS will also consider:
- Does the time and effort you put into your hobby indicate the intention to make a profit?
- Are you dependent on hobby income?
- Have you changed the way you work to improve profitability?
- Do you have the knowledge you need to pursue your hobby as a successful business?
- Have you profited from similar activities in the past?
- Do you expect to profit from the appreciation of the assets used in your hobby in the future?
From a tax standpoint, you cannot claim any hobby deductions. Businesses, on the other hand, offer the benefit of deductions.
Why business registration is good
Claiming business rights allows you to offset losses incurred in some transactions with the profits incurred in others. In fact, most business expenses can be deducted from the gross income of your business, which limits your taxable income in advance before the IRS can collect it. It includes:
- Capital expenditures for business improvement
- Interest on loans
- Fees and Subscriptions Paid to Business-Related Organizations
- Office space and equipment, including furniture and computers
- State and city taxes
- The business part of your home
- Business mileage on your car
- Fee for related education
- Insurance, wages and employee benefits.
Next Steps to Sharing Your Business Finances
Sharing your business finances will simplify your taxes and save you the hassle if you ever get verified by the IRS. Below are some general guidelines for separating personal and business finances.
Create a separate checking account and credit card
Combining personal and business expenses will lead to tax headaches. To simplify your accounting, keep your personal and business funds (and receipts) separate.
Set aside 30-40% of your side labor income for taxes.
Business taxes related to freelance income can be hard to predict down to the last dollar, but a general rule of thumb is to set aside 30% to 40% of your income for federal, state, and self-employment taxes. You will need to make quarterly tax payments if you expect your annual tax return to be in tax arrears on freelance income of $ 1,000 or more.
Make your business a legal entity
If your side gig is in trouble with the law, your personal assets could be at risk. You can protect your assets by turning your business into a legal entity , either by setting up a limited liability company (the simplest business structure for a one-person business) or by registering. You might want to consult with your CPA about which options are best for you.
Apply for an Employer Identification Number (EIN)
Instead of giving your social security number to a customer, buyer, or supplier, you can give them an EIN . The EIN, also known as the Taxpayer Identification Number, is used by the IRS to track the income of your business. You will also need an EIN to open a business account with your bank and hire employees.
Apply for a DUNS number
The DUNS number establishes the identity of your company, which is completely separate from your individual credit profile. Establishing and monitoring the loan of your business is essential for establishing payment terms with suppliers and becoming eligible for the loan.
Implement a separate accounting system
Hiring an accountant or bookkeeper can be costly if you are running a very small business on your own. Luckily, there are good accounting software options out there with automated features available, such as syncing transactions with PayPal or Square. Some of the more commonly used programs include QuickBooks Online Accounting , FreshBooks , Xero, and Wave (which are free).
Log the hours you spend on your business
Your time is precious. To properly measure your income, you need to make sure that the total price you charge the client is greater than your business’s cost of completing this project.