You might be aware of tax deductions for side businesses (also called expense deductions and tax write-offs), that businesses and large corporations use to reduce the amount of profit they report to the IRS, and thus, reduce the amount of taxes they have to pay.
Did you know that you can do the exact same thing with your side hustle?
In the eyes of the law, any side hustle that earns more than $400 a year is exactly the same as a small business, which means that if you’ve structured your hustle legally — which you should — you can take advantage of the same tax deductions that other businesses do.
Good expense reporting isn’t complicated and can save you a chunk of change. It might even reduce your tax liability to zero, and may encourage you to invest in some great assets for your hustle in the process, like new equipment, a business phone, or even a website.
Here’s how it works.
Profit = Revenue – Expenses
The basic premise is this. If you are a business owner running a sole proprietorship or LLC, at the end of the tax year you only pay taxes to the IRS on your net income or profit.
Profit = Revenue – Expenses
You report both your revenue and your expenses together at the end of the year. If your expenses are equal to revenue, your profit is zero, which means you won’t pay any taxes at all that year. I’m sure somebody will figure out a way to shake coins out of an empty wallet eventually, but for now, it’s tough to tax zero.
That’s why it’s so important to keep track of your legitimate business expenses, which you’ll report at the end of the year on a separate form. It can save you a significant amount of cash.
But what, dear reader, constitutes a legitimate business expense? Well, not just anything. But a lot of things.
Tax Deductions for Side Businesses are Ordinary and Necessary Expenses
The IRS defines tax-deductible business expenses (write-offs) as “ordinary and necessary expenses” for the operation of your business. That means anything you’re going to report as a business expense has to be something your hustle genuinely needed to do business.
This concept is absolutely vital for allowing businesses to invest in their own growth (which includes you, side-hustler). The wild thing about this is that the IRS hardly ever audits the thousands upon thousands of small businesses that spring into existence each year. For good reason — it would be like playing a never-ending game of whack-a-mole. It’s just not worth their time.
This means you can, in theory, tell the taxman you had all sorts of expenses that you really didn’t. People do that every year on every level of businesses, from sidehustler, to corporate con.
But that’s called tax fraud. That’s real bad, and you will eventually be caught.
Unfortunately, new hustlers who don’t understand tax deductions may accidentally commit tax fraud by deducting items that weren’t really “ordinary and necessary,” but were just, sort of, I don’t know, nice to have?
Here’s the general rule of thumb. If a purchase will make the businesses more money, it’s an ordinary expense. If the business could not make money at all without a certain purchase, then that purchase is a necessary expense.
Examples of tax deductions for side businesses
Here are a few examples.
If you bake cakes out of your kitchen, you can’t deduct the cost of your hotel room in Vegas last weekend during your best friend’s wedding. That wedding had nothing to do with your baking hustle. Reporting your Vegas trip as a travel expense would be tax fraud.
You can deduct the cost of a new kitchen mixer or a set of baking pans, because without baking pans you can’t make cakes at all; and with a new mixer, you can make way more cakes to sell, thus generating more revenue for the taxman. These expense deductions are Uncle Sam-approved.
If it’s for the business, you can deduct it. If it’s not, you can’t. Makes sense, right? Here’s where it starts to get fun.
Overlapping personal and business expenses
What happens, you might ask, when you use the same kitchen mixer to make cakes for your customers and for yourself? If you use that kitchen mixer that was bought on the business’s dime for personal purposes, was it really a business expense?
The answer is yes. Maybe.
As a business owner (which you are, if you’re a side hustler) it is not illegal for you to use business assets for personal purposes.
However, in order for you to deduct the cost of purchasing that new kitchen mixer from the business’s taxable income, the mixer must be used primarily for business purposes.
If you use it all week to bake cakes for the business, then make a birthday cake for junior on Saturday, that’s fine. You can still deduct the cost of that mixer.
If you use the mixer to make cakes for your family and friends all year long, and use it only once or twice a year to make cakes that you will actually sell, that’s not a deductible business expense. That’s a mixer you bought for your own enjoyment, and reporting it otherwise is tax fraud.
Deducting only part of a business expense
This concept works for all kinds of common overlapping expenses, including cell phones, equipment and tools, computers, cars and car insurance, even home offices.
The IRS does, in some cases, allow you to deduct a portion of the cost of overlapping expenses. This means that if you use your new mixer to make 5 cakes a month for business, and 5 cakes a month for personal consumption, you can deduct 50% of the cost of the mixer from your taxable income, because the business is only using 50% of its operating time.
However, tax laws around this are always changing, and those are profoundly boring nuances beyond the scope of this article. Scroll to the bottom for further reading.
How much can you save with tax deductions for your side business?
Time to put it all in perspective. Just how much will all these financial gymnastics net you at the end of the year?
Let’s say you brought in $5,000 of revenue from your cake-baking hustle this year, and you spent $3,000 on business expenses.
Here’s a handy-dandy chart to show you just how much you might pay in taxes if you don’t report the tax write-offs for your side business, vs if you do.
|Net taxable earnings (profit)||$5,000|
|20% federal taxes||$1,000|
|6% state taxes||$300|
|15.3% Self Employment||$765|
|With deductions (write-offs)|
|Net taxable earnings (profit)||$2,000|
|20% federal taxes||$400|
|6% state taxes||$120|
|15.3% Self Employment||$306|
These are ballpark figures and your specific tax rates will likely differ, but they make the point.
Look at the difference between the total amount of tax you would pay. The difference is about 1200 dollars in your pocket. That’s nothing to sneeze at.
Plus, if you were going to spend $3,000 on business assets anyway — like the ingredients for your cakes, baking tins, our old friend the cake mixer, a business cellphone, a business laptop, office supplies, packaging, customer appreciation cards, even an ad in your local paper — it would be crazy not to do your expense reporting and save 1200 bucks.
Don’t buy things just to write them off on your taxes
It’s very important to note here, that it makes NO sense to purchase new assets for your business just to save on tax writeoffs.
In our example above, our little cake business spent $3,000 on business assets and only saved about $1,200 in taxes. That means we’re still $1,800 in the hole. So unless we actually needed all the supplies and services we spent that $3,000 on, we were better off not making the purchases at all.
One notable exception to this is if a tax-deductible purchase will just barely land you in a lower taxable income bracket. Companies of all sizes play this game at the end of each fiscal year. It’s legal and can be entirely ethical, but I don’t recommend it for side hustles. Your side business is supposed to be about baking cakes, not gaming the system.
How to start recording tax write-offs for your side business
You might be thinking, ok . . . so, how do I actually do this?
I am not a CPA or tax attorney. I’m just a guy who has run a small business or two and learned from the ground up. And trust me, I learned the hard way that when it comes to something as complex and eternally fluid as American tax law, the only smart thing to do is get professional help.
If you’re serious about doing taxes right and finding every possible tax write-off for your side business, you should always seek the advice of a certified CPA or tax attorney. Get recommendations from local business owners you respect and make this investment in your financial peace of mind.
To prepare yourself for that conversation, I recommend first reading the IRS rules on business deductions. Hammer out the taxes, then get out there and get back to having fun and making money with your side hustle!