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With the explosion of the gig economy comes many questions from those participating. One of those questions seen often is, “How does this impact my income tax bill?” You may be surprised to know many gig workers or those with a side hustle will typically find themselves owing taxes, even if they have always received a tax refund in the past. Of course, this can come as a shock to find out money will be flowing in the opposite direction than you expected.

As with any income received the government will want to receive their portion of the funds. For those used to working as a W-2 employee and having their taxes taken out of each paycheck, paying taxes may be a bit of an afterthought, but with the freedom of working when you want, where you want comes the responsibility to set aside the money needed for taxes.

The reason many with a side hustle such as, opening an online store or driving for a ride share app, end up owing taxes because there is no tax withholding in their pay. In a traditional W-2 employee position the W-4 you fill out when your hired determines how much tax is removed from your paycheck before that money hits your bank account. This helps spread your tax burden out over the course of a full year and can many times lead to an overpayment triggering your tax return. When self-employed income is introduced the money hitting your bank account has not had any federal taxes taken out. So, if you earned $50,000 in taxable income in your day job and an additional $10,000 in a side hustle you will have taxes withheld from your paycheck to help cover your first $50,000 in taxable income but nothing from your $10,000. Based on 2019 tax rates for a single filer it looks as follows:

The first $50,000 will become $37,800 after your standard deduction. The total tax bill owed on this amount would be $4,342 with a marginal tax rate of 12%. If you are paid bi-weekly and you withhold $167 per paycheck you will not owe anything more when you file your taxes. Now, if we add in $10,000 in self-employed income from a side hustle not only do you pay tax on that entire $10,000 in income but it actually bumps you up to a higher marginal tax rate of 22% and creating a total tax bill of $6374.50. If you only had the $167 withheld from your taxes each paycheck you would find you owed an additional $2,032.50 in federal income tax after you filed your taxes.

This is a simplified example used to illustrate the importance of setting aside extra money from your side hustle to cover your end of the year tax liability. The last thing you want is to have spent that entire $10,000 just to find out you now owe $2,032.50. Always refer to your tax specialist when determining a good amount to hold back and to help find any deductions that may decrease your tax liability as well.