The increasing viability of remote work and the booming gig economy have meant that more and more people have a side gig, or have even taken the plunge to start their own fully fledged small business. Unfortunately, with a side gig or small business, comes questions about how to handle taxes. Here's what to know about planning for taxes for your side hustle or small business.
Account for every dollar
We recommend a book called Profit First (by Michael Michalowicz) to aspiring small business owners, because it discusses a way to break your money into five different categories and dig into the accounting process. Accounting for a small business can be a giant pain, so any help you can get along the way will take some of the burden off your shoulders.
The most important thing to remember about taxes for your small business is that every dollar must be accounted for, and then categorized. This is true whether you've made $1,000 in a year, driving for Uber or delivering food for DoorDash occasionally, or you've struck it rich with a brand-new tech startup. While you may not consider your weekend job as a rideshare driver to be a small business, the IRS does, so it pays to plan accordingly.
You can write off business expenses
The bonus of having a small business is that you get to write off your business expenses. The first write-off that likely comes to mind is your home office, and yes, if you work from home and are self-employed, you get to take the home office deduction. But you can also write off your expenses for purchases like computers.
Don't just assume that every purchase meets the requirements to be a write-off, however. If you buy a new computer for your business, that qualifies. But you can't just buy a new gaming PC and decide to call that a business expense. Similarly, if you work from home, but buy a new car, you can't call that a business expense. It's not a good idea to play games with the IRS.
Keep your business and personal finances separate
A word of caution: Don't mix your personal funds with your business funds. For one thing, doing so may impact the protection you have as a business owner, depending on how your business is set up (such as a Limited Liability Corporation, or LLC). At the very least, mixing business and personal money will make accounting an even bigger pain. So open a bank account specifically for your business, a credit card for your business, and so on.
Along the same lines, it's also a good idea to maintain separate financial plans for your business and your personal funds, so you can see where they inevitably cross over. For example, if you take out a small business loan, it will be on you personally to pay it back, ideally out of the money your business earns. Your accountant and Childfree Wealth Specialist can help with financial considerations for your work and your personal expenses.
You'll pay taxes quarterly
When you're a W-2 employee for a company, your taxes are taken out of your paychecks. This isn't the case if you're self-employed or own your own business. Instead, you'll owe estimated quarterly tax payments to the IRS. These are intended to represent 25% of the taxes you'd pay over the whole year, and you owe them in January, April, June, and September. As you can see, this doesn't actually divide the year into even quarters; you only get two months between April and June, for example.
You estimate these payments based on how much you made the previous year, if you expect your earnings to be the same. This is where things can get complicated, and where it's best to approach your small business taxes with the help of an accountant and a Childfree Wealth Specialist. In addition to paying federal taxes, depending on what state your business is in, you might also owe state taxes every quarter.
It's best to stay on top of these estimated payments, because if you don't pay them on time and in full, you'll owe penalties. If you can plan when to make large purchases for your business, you can strategically limit your tax liability for that quarter. This is yet another piece of the puzzle that an accountant or CFP® professional (or both!) can help you with.
You can create your own retirement fund
Owning a small business isn't all gloom, doom, and taxes, however. One advantage you have is that you can open a SEP IRA or a Solo 401(k), which amounts to your own self-managed retirement plan. And you can add money to it as both an employer and an employee, meaning your contribution limits will be higher. You might be able to add a lot more money to one of these accounts than you could as a W-2 employee. Consult with your accountant or Childfree Wealth Specialist to learn more.
If you've started your own small business, the odds are that you're great at whatever you do. But financial planning is likely not your forte, and as such, it pays to rely on financial professionals to help you keep everything straight for taxes, retirement accounts, and beyond.
Jay Zigmont, PhD, MBA, CFP® is the Founder of Childfree Wealth, a life and financial planning firm dedicated to helping Childfree and Permanently Childless people. Dr. Jay is a CERTIFIED FINANCIAL PLANNER™, Childfree Wealth Specialist, and author of the book “Portraits of Childfree Wealth.” Dr Jay is the co-host of the Childfree Wealth Podcast. His Ph.D. is in Adult Learning from the University of Connecticut.
He has been featured in Fortune, Forbes, MarketWatch, Wall Street Journal, New York Times, Business Insider, CNBC, and many other publications.