And if you don’t, your side hustle just might not make it.
1. Not keeping accurate income records
Since side hustles are typically second occupations, it’s very easy to be casual with record-keeping. Never is this more likely than in the first year of operation. You might simply be looking for some extra money, so you don’t bother to track the actual dollars and cents.
This habit has a few bad side effects:
- Though money may be coming in, you’ll never be entirely sure how much.
- Since you’re not really sure how much is coming in, you don’t really know if the business is truly successful.
- Though you may be making money, you won’t know if what you’re earning is justified by the time and effort you’re putting out to earn it.
- When tax filing time comes, you’ll be forced to estimate and guess how much you actually made. That can be a disaster if the IRS doesn’t agree.
Solution: Set up a dedicated bank account where you will deposit all of your side hustle income payments. At the end of the year, or the end of each month, you can simply total up the deposits to determine your income.
2. Not keeping accurate expense records
New side hustle operators may be even more casual when it comes to recording expenses. This is particularly true if the expenses are small.
There is an equal number of issues with this practice:
- You’ll never know what your net income is—that’s your income after deducting business-related expenses.
- If you focus only on the income side, and ignore expenses, you’ll never know if your side hustle is truly profitable.
- You’ll miss out on valuable tax deductions against your side hustle income.
Solution: Purchase business accounting software, like TurboTax, and record all of your expenses—as well as your income—as they occur. Alternatively, you can set up a dedicated business checking account, that you run all your expenses through. That will provide you with an automatic written record of your expenses. You can also deposit your side hustle income into the same account.
We’ve already talked about how not accurately recording your income and expenses can lead to not knowing your true net income. But there’s an even more specific problem. Without keeping records, you can’t know how cost-effective your expenses are.
The primary purpose of business expenses is to generate business income
Without keeping accurate records, you’ll have no way to measure the income benefit provided by any particular expense.
In order to maximize profits, a business owner has to know which expenses will produce the most “bang for the buck”. Without keeping accurate records, you may be incurring expenses that generate little or no revenue. You may also miss an opportunity to determine which expenses produce the highest revenues.
Solution: Using accounting software, you should be able to match expenses incurred with the relevant income produced. You can then look for inconsistencies. Are there expenses that produce little or no benefit? Are there others that result in increased income? Properly allocating between the two will keep your side hustle going in the right direction.
This is a mistake that even side hustle veterans make. If you’re running your side hustle income and expenses through a personal checking account, separating business and personal could be so complicated that you don’t bother to do it.
Until tax time.
That’s when it becomes a certified nightmare. Trying to separate business and personal transactions out of 12 months bank statements can take days. That’s especially true if you make personal purchases from the same vendors you make business purchases through. It will also be a problem if you don’t have a record of side hustle related income deposits.
Solution: Once again, the most effective solution is to have a dedicated checking account for your side hustle. Use that account exclusively for your business so there’s no possibility of mixing with personal transactions.
This includes debts you’ve incurred for business purposes, or debts owed to you in connection with your side hustle. It also includes accounts receivable—income earned, but not yet collected—and accounts payable—expenses incurred, but not yet paid.
If you don’t keep track of debts and obligations, you could lose side hustle income, or fail to make timely payments. The latter could result in damage to your credit, as well as your reputation.
Solution: Accounting software should have general ledger capability, that enables you to set up individual accounts. They can be set up for debts, receivables and payables. If you have terms set up with multiple customers or vendors, this will be the only way to keep accurate records of what you owe, and what’s owed to you.
This is a definite problem if your side hustle involves selling a product. But in many states, sales tax also applies on certain services performed.
Whether you actually collect sales tax from your clients and customers may not matter. But the state sales tax division will want their cut anyway. You’ll have to keep accurate records of your business income, as well as your sales tax liability. In fact, sales tax is a payable, just like an account payable due to a supplier or vendor.
Solution: Accounting software will be a must if you are required to collect and pay sales tax. If the software has an invoicing feature, it will automatically include sales tax in customer invoices. And as payments come in, the sales tax will be credited to the sales tax payable account. At the end of the month, you’ll know exactly how much sales tax you owe. Pay it when required—sales tax divisions are notorious for being unforgiving.
7. Not making your estimated tax payments
If you don’t make estimated tax payments on your side hustle, you’ll owe money at the end of the year. This could leave you with a very large tax bill at filing time. Like thousands of dollars. If your side hustle is particularly successful, it could even be tens of thousands of dollars.
If you fail to make those payments in a timely fashion, you’ll owe interest and penalties on top of the basic tax. It’s a Catch-22 situation you can never win.
Solution. This gets down to why you need to keep accurate records of both income and expenses. If you do, you’ll be able to determine your net income at any time (net income is also generally your taxable income). You’ll need to make estimated tax payments to the IRS during the course of the year. Those tax estimates are due on April 15, June 15, and September 15 of the current year, and January 15 of the following year—all for the current tax year.
Once you determine your net income for the quarter, you’ll have to apply your marginal tax rate to the income. But you’ll also have to pay self-employment tax, which is the FICA tax for the self-employed, and those who have side hustles.
The rate is 15.3 percent of your net income.
If you’re in the 15 percent marginal tax bracket, you’ll have to allocate roughly 30 percent of your net income for estimated tax. If you don’t know how to calculate this, consult with an accountant. You can make your tax estimates online, using IRS Direct Pay.
When you have side income, taxes can get complicated quick. These are seven common side hustle accounting mistakes to avoid, but your best bet is to get some good accounting software, or a good accountant.
- Got Freelance Income? 7 Money-Saving Tax Tips
- Act Now To Save Money Come Tax Time: Tax Deductions For Freelancers