- Households under financial pressure are finding different ways to generate a few extra dollars, from selling crafts to generating video content.
- Though independent contractors may get a Form 1099 from the platforms they use to do business, they are required to report all income they receive from their side work and pay taxes on it.
- Simplify your workload at tax time: Track your income and expenses, and be sure to set aside some money to cover quarterly taxes. You may be eligible for small business deductions, too.
What started out as a fun at-home activity for Amy Abad-Sosa has turned into a source of small business income.
The 29-year-old mom of two and bookkeeper, based in Bogota, New Jersey, kicked off her new venture "Adventure Bins" this fall – homemade activity boxes for toddlers and preschoolers.
"We're not dumping thousands of dollars into this, but it's not a bad idea to have some extra money coming in," she said.
Though the pandemic has squeezed numerous small businesses and dented household income for millions, it has also spurred people to find new ways to make money – be it through creating and selling activity boxes, delivering food or finding other forms of freelance work.
Influencers on the internet are also monetizing content, from make-up to manicure tutorials.
OnlyFans, a subscription service that acts as a video platform for influencers, had a 75% month-to-month increase in new creator registrations between March and April – just when the pandemic was taking off.
However, a surprise is around the corner for these new entrepreneurs.
They'll need to account for the money they've been earning and report it on their 2020 income tax return.
"The number one problem when starting a new business or a side business is that you don't understand the tax environment," said Mackey McNeill, CPA and consumer financial education advocate for the American Institute of CPAs.
"You take your box of materials to your CPA and they're like, 'You owe $5,000 to the government,'" she said. "That first year out of the box, you are behind and indebted to the government."
Here's how to head off those first-year tax mishaps.
Know your obligations
Regardless of whether you just started your new side business or you've been operating for years, you'll need to report the income on your 2020 tax return.
Some online services, including Uber, OnlyFans, DoorDash and Etsy, will issue you a Form 1099 in January, detailing the money you've earned in the prior year. A copy of this form goes to the IRS as well.
Here's the catch: Not all services will give you this information. For instance, in order to receive a Form 1099-K, merchants on Etsy must have made at least $20,000 in sales via Etsy and they must have received at least 200 payments that year.
Even if you don't get a 1099, you're on the hook for accurately tracking and reporting income.
"For people doing things out of their home – for instance, making and selling crafts – unless you go through a marketplace like Etsy or Shopify, you're tracking it yourself," said Paula Small, a small business bookkeeper and owner of Small Stepping Stone in Manassas, Virginia.
More from Smart Tax Planning:
Wealthy families hoping to save on taxes are in limbo
This is the maximum you can save in your 401(k) plan in 2021
Here are the new tax brackets for 2021
"Services like GrubHub and DoorDash will have some reports you can log into, but they won't issue a Form-1099 until January," she said. "By then, you've already forgotten about everything you did the year before."
Maintain a spreadsheet with your income and track your expenses. Consider maintaining a separate business bank account to give you a better view of dollars coming in and expenses going out.
For now, Abad-Sosa uses Google Sheets – free spreadsheet software – to track her income and expenses, including the cost of crafts and shipping fees.
"The bookkeeping is my baby," she said. "If you're just starting a small business, keep an Excel sheet of what you pay and what you're buying."
Set aside cash for taxes
Small business owners pay quarterly estimated taxes. The due dates are Jan. 15, April 15, June 15 and Sept. 15.
This can come as a surprise to new entrepreneurs who are accustomed to having income taxes withheld from each paycheck as employees.
Here's another tax lesson: While employees share the burden of payroll taxes with their employer – 12.4% for Social Security and 2.9% for Medicare – self-employed people pay the entire amount themselves. It's part of their quarterly payment to the taxman.
Talk to a tax professional about exactly how much you'll need for each quarterly payment to the IRS. In general, setting aside 25% to 35% of your income is a good rule of thumb, according to Small and McNeill.
Watch your expenses
When it comes to deductibility of expenses, the IRS has a set of rules that determine whether a venture is a business or a hobby.
All income must be reported, but if you're engaging in a hobby, you can't deduct the expenses you paid to participate.
Nevertheless, track your costs and have them ready when it's time to file your taxes.
"Gather all your expenses so you can get the deductions you're eligible for and lower your net income," said Lisa Greene-Lewis, CPA and TurboTax expert.
Those breaks can include the home-office deduction, the mileage deduction, as well as expenses incurred when you bought materials and equipment necessary for your business.
Hire a pro
Invest in yourself. Hire an expert to walk you through year-end tax planning and get you on solid footing for 2021.
This tax year might prove to be a complicated one, given that taxpayers could be juggling a Form W-2 from their regular job, as well as multiple 1099s from unemployment and different sources of side-gig income.
"Good advice is a healthy return on investment," said McNeill. "Now is the time to think about what 2020 will look like for you and whether you'll be happy or sad when April comes around."