Set Aside Money To Pay Taxes
Whether they’re renting out a spare room, driving others, delivering food or products, selling crafts or offering services online, many people are trying to find new and interesting ways to make money outside of their nineto-five jobs. Some turn to online platforms that connect contractors with work and others are creating their own small businesses. Either way, a side gig can help you make ends meet or provide you with extra spending money.
The idea of joining the “gig economy” may be even more enticing for some after the passage of the Tax Cuts and Job Act (the new tax bill), which offers some contractors and business owners a tax break if they meet certain outlined criteria. Even if you’re eligible for the new deduction, you should still plan ahead to avoid a surprise next tax season.
What does the new tax bill offer freelancers and contractors? In short, you may be able to deduct 20 percent of the net income (your income after expenses) you earn as a sole proprietor or contractor. Owners of a pass-through entity, such as an S-corporation or limited liability company (LLC), could also be eligible.
The deduction doesn’t apply to income you earn as an em- ployee of a temp company, even if you’ve moved from one shortterm gig to another. And there are exceptions for high-income earners. But many people who work a regular job and have a side gig, or even a few side gigs, could be eligible.
Freelancers and contractors still have to pay taxes. The new deduction could help limit how much you’ll owe when you file a tax return next year. However, even if you are eligible for the deductions, your net income will likely still be subject to income taxes – you should consult a tax professional for further information. You could also have to pay Social Security, Medicare and self-employment taxes on all your earnings (including the deductible portion).
Unlike income earned as an employee, when you work as an independent contractor, taxes generally aren’t taken out of your paychecks. As a result, contractors could face a hefty tax bill because they’ll owe the full amount at filing time.
If you don’t want to be caught off guard at filing time, consider one of the following ways to prepare:
Save part of your contract income. Knowing that you’ll eventually have to pay taxes on the contract or freelance income you earn, you could set aside a portion of the money in a savings account as you receive it. An added financial benefit of doing this is that you could earn interest on the savings throughout the year.
Make estimated tax payments. If you owe more than $1,000 in taxes when you file your return, you may have to pay an additional penalty for underpaying your taxes throughout the year. To avoid this, you can make estimated tax payments online, by phone or by mail each quarter.
Increase your W-4(s) withholdings. If you’re an employee (as opposed to a contractor), the Form W-4 you fill out helps the company determine how much money it should withhold and send to the IRS from each of your paychecks. When you start a new side gig, you can update your Form W-4 and change your withholdings based on your new total income.
To determine the correct withholdings, you can use the worksheet attached to the W-4 or try the free IRS tool online. Once you figure out the correct withholdings amount, fill out a new Form W-4 and give it to your company’s HR department (or whoever manages your payroll). You can update your W-4 as many times as you want throughout the year.
Bottom line: There are many ways to get a side gig and earn extra money, and the new tax bill means many contract workers may be able to keep more of the money they earn. However, freelancers and contractors should still take steps throughout the year to avoid being caught off guard when they file a tax return next year.
Hugh Norton directs Visa’s financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney.