If you work full or part time, but have a side hustle, even if it only generates a small amount of revenue, you may want to take a few moments to read this article.
The IRS has been cracking down on folks with a side hustle income and if you fall into that category, it would be prudent for you to understand what a side hustle is, how to report it, and what the penalties are if you don’t.
Definition Of a Side Hustle
A side hustle is a flexible, independent, typically skill-based activity, usually driven by passion and necessity. The side hustle income is essentially any income supplemental to your regular income and is earned outside a job where you’d receive a W2 wage statement at the end of the year.
It doesn’t matter if it was part-time, occasional work, or seasonal work, if you received income in exchange for a product or a service that you provided, the IRS expects that income to be reported on your tax return. You’re even on the hook if you’ve received income from a hobby you’re doing for fun. For example, if you like to paint landscapes, and you happen to sell one of your paintings to somebody, you’ve just derived income from a hobby and you should report that income on your tax return.
Why Is The IRS Cracking Down?
So, why is the IRS cracking down on “side hustles” right now, even on small dollar amounts? Simply put, because they can. With today’s technology there is little to no effort on the part of the IRS to follow your transactions and income. Banking platforms track transactions, deposits and withdrawals, marketplaces track sales, and payment processors create and report records.
The IRS identifies who to go after using a matching strategy. Essentially, the IRS compares what you report on your tax return to what third parties report to the IRS about you. If, for example, Venmo reports that you received $1400 in payments, but you didn’t include an income line for that $1400 on your tax return, then obviously those numbers don’t match up, and a computer is going to flag it. It’s an automated system that notices a mismatch between what you report and what others report about you.
Common Mistakes
There are several common mistakes people make when operating a side hustle to make additional income. Below are the five most common mistakes to be aware of:
Mistake #1 – Thinking The Amount Of Income You Received Is Too Small To Matter
Let’s say you made some side hustle income, you didn’t report it to the IRS, and nothing happens. It’s not because the amount you made was too small to matter. You didn’t get an IRS letter because the IRS didn’t catch it and they didn’t know about it. However, if they do detect your income, the small dollar amount is not going to protect you.
Let’s just say that you made $2,200 from a side hustle and the payer sends you a 1099. Yet, through an honest oversight your tax return shows zero. The mismatch is going to be clean and obvious and that’s going to trigger an IRS letter.
Let’s take the same scenario, you made $2,200, received a 1099, and again, through an honest oversight, forgot to report it, but this time your expenses were greater than your income, meaning you had zero profit and zero taxable income. The IRS is still going to see you received $2,200, but they’re not going to see the expenses that would have offset the income. As a result, they’re going to have you pay taxes on the gross amount you received, $2,200 when you actually could have offset that income with your expenses had you reported it on your return.
Mistake 2 – Waiting For a 1099 Regarding Side Hustle Income
This mistake gets a lot of people in trouble. They wait around for a 1099, and when it never appears they assume they don’t have to report that income. But, it doesn’t work like that. Here’s the rule of thumb that will save you. You must report your income whether or not you receive a tax form. If you don’t get a 1099, that doesn’t just magically erase the income you made. It’s entirely possible, especially in this day and age, for a 1099 to have gotten lost in the mail, or be sitting in a junk folder in your email application in the case of an electronic version, or in some cases, the individual didn’t realize they had to log on to a web site and download their 1099.
If you think because you didn’t receive a 1099 your income was never reported to the IRS, you may find yourself on the wrong end of that assumption. You not receiving a 1099 is not an indication that the IRS hasn’t received one regarding your income. Using the excuse that you never received a 1099 isn’t going to garner any mercy with the IRS. The IRS isn’t going to care if there was a problem with the US Mail, an email problem, a communication problem, or that your computer couldn’t download your 1099. It’s ultimately your responsibility to report your income correctly.
Mistake #3 – Thinking Cash payments Are Going To Be Invisible To The System
Mistake number three is believing that working in an all cash economy, using cash payments and cash apps, means your income will be invisible to the banks and IRS. And frankly, when dealing with cash payments it certainly is more difficult for the IRS to have you on their radar.
However, many people who receive cash payments end up generating bank deposits, making rent, car or utility payments, creating bank transfers, etc. And if you ever DO get audited, your paper trail is going to be very obvious to an IRS agent, and those patterns are going to matter and are going to be very difficult to explain after the fact. If you get paid in cash and make a bank deposit of cash every week, or you have consistent payments through apps such as Venmo, Zel, or PayPal, the IRS is going to be tipped off and will question it. If you can’t explain it with your records, you’re going to have a problem.
Mistake #4 – Mixing Personal Finances With Side Hustle Income
If you run your side hustle through your personal bank accounts, you’re going to create a documentation nightmare, and this mistake is going to cause chaos at tax time. Think about it. Your side hustle income and your personal transfers and transactions will be comingled. You won’t be able to easily show what was related to your side hustle as a business deduction and what was a personal expense. Also, your legitimate business expenses, being mixed in with your personal finances, could be overlooked and forgotten. As a result, you’re either going to overpay taxes because you forgot to claim real expenses related to your side hustle or you’re going to underpay taxes because you’re just guessing.
The simple solution is to separate accounts. As a minimum you should use a separate checking account and/or a separate credit card for the expenses related to your side hustle. Doing this one thing will help you avoid this accounting nightmare.
Mistake #5 – I’m Not Running An LLC or S-Corp So I’m Not Running A Business
Some people believe they need to be running their side hustle as an LLC or S-Corp or some other business entity, in order for any money they make to be taxable income. The truth is, as stated above, if you derive even a small amount of income from any activity, even a pleasurable hobby, such as woodworking, painting, pottery, glassblowing, etc., you are responsible for tracking the expenses and income from that hobby. Remember, income is income, no matter how you make it, or how it’s paid to you.
How Can They Track All This?
How is it possible for the IRS to track all of this? Because the whole system and processes within the IRS are automated. Their software scans tax returns and analyzes them for any oddities. If the algorithm indicates your tax return looks suspicious, it’s going to trigger an IRS letter. And since everything’s automated, it’s not a labor-intensive process for the IRS, nor is it expensive relative to the return on the effort. As a result, they’re capable of sending millions of IRS letters to Americans even if their suspicions revolve around much smaller dollar amounts.
How Do I Keep My Side Hustle, And Myself, Out Of Trouble?
If you want to keep yourself and your side hustle out of trouble, here’s a simple approach:
First, keep track of your side hustle income and expenses. Don’t rely on a1099 at year end. You don’t need fancy software, you can use a simple spreadsheet to keep track of costs and income
Second, separate your side hustle income from your personal finances. As stated above, you don’t want that accounting nightmare at the end of the year. Be sure to keep basic records like invoices, receipts, platform statements, etc.
Third, don’t guess your expenses. Document them, have them organized, and of course, set aside money for taxes as you go.
Fourth, remember, income is income. It matters not how you received it or in what format. If you received it electronically via Venmo, in $20 bills from one person to another, or if you received silver bullion, it’s income. And even if you’re dealing in a cash business, in this day and age it’s becoming more and more difficult to hide those types of transactions. If you earn income, you’re going to spend it somewhere, and if you spend it, you leave a paper trail. Remember that.
Final Thoughts
This is not about instilling fear. It’s about getting ahead of the situation and staying organized so that you’re in control. The people who have the hardest time during tax season are the ones who are disorganized and say, “I’ll just deal with it later.” It’s best to keep track of your expenses and income and report it properly rather than receiving a letter from the IRS and then having go through the trauma of an audit. These days, side hustles are more common than ever. As a result, the IRS has been adapting to this modern economy by using tools and software that makes income easier to detect and track. The bottom line is that the IRS wants their money. If you put yourself in a position for them to come after you, they’re most likely going to come after you and on top of everything else, impose fines and penalties when applicable.
Avoid these mistakes, stay organized, and enjoy a successful “side hustle”.
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