With the number of taxpayers working in the so-called “gig economy” rising relentlessly, it’s more likely than ever that a client is holding down a side job for extra cash, to transition into a new career, or for some other hope-filled purpose. What they are they less likely to do, though, is pay attention to the tax ramifications.
“Small-business owners must be disciplined to pay estimated quarterly taxes,” said Gail Rosen, a shareholder and CPA at Wilkin & Guttenplan in Martinsville, N.J., and “make sure that the bookkeeping is in order so [they] don’t miss business expenses.”
“They usually don’t set aside enough cash to pay the tax bill, which includes not only the income tax but also the SE tax,” said Scott Kadrlik, a CPA with Meuwissen, Flygare, Kadrlik and Associates, in Eden Prairie, Minn.
“There may not be a future for W-2s, just 1099s,” said Larry Pon, a CPA in Redwood City, Calif.
Plethora of issues
If your client is employed at a company and has work on the side, “a plethora of issues and concerns” arise, according to Pon:
- Does the employer prohibit outside work? “I’ve seen employment contracts that expect you to devote 100-percent-plus of your attention to the employer,” he said. “It doesn’t matter if the side work is in the same business or not.” Pon’s example: the IRS itself. “You can have part-time jobs outside of your work hours [but] you cannot have a tax-preparation business.”
- Is the client using their employer’s resources to do side work? Are they doing the work during business hours? Are they also trying to deduct the office computer? Are they using the employer-provided cell phone?
- How much income is the side gig generating? Do they need to consider paying estimated taxes? Do they need to pay local business taxes?
Kelly Phillips Erb, who blogs as “Tax Girl” on Forbes.com, reports that according to a recent survey more than a quarter of Americans earn cash on the side but don’t declare it. “In terms of dollars,” writes Erb, “about 69.8 million Americans are failing to report an estimated $214.6 billion to the IRS each year. The biggest offenders? Millennials, according to the survey.” Survey results also indicate that more than a third of those earning incomes of $150,000 to $300,000 make money on the side without claiming it, more any other income bracket.
‘Sloppy’ or ‘valuable?’
Not all side-hustlers are the same. “If it’s self-employment, they could have a significant tax burden at the end of the year if they aren’t doing estimates. If it’s a W-2 employer, it’s common to under-withhold on a second job,” said Laurie Ziegler at Sass Accounting, in Saukville, Wis.
“Clients, especially those who come from a more traditional wage-earner background, don’t realize the importance of recordkeeping and keeping track of their income and expenses,” said Phyllis Jo Kubey, an Enrolled Agent in New York. “Often we find out about the new venture after the fact and have a major reconstruction project to correctly report the year’s activity.”
Quarterly estimated tax payments are also a foreign concept to many taxpayers who have never been self-employed, “and this can be particularly challenging for taxpayers with erratic cash flow,” Kubey said.
“I have one client who does a legitimate personal service, a side business, as she’s retired. I dread her lack of recordkeeping and ability to separate expenses for the business from personal use,” said Morris Armstrong, an EA and registered investment advisor at Armstrong Financial Strategies in Cheshire, Conn.
“I do look at her business bank statements and, fortunately, there aren’t that many transactions. She operates alone so there are no payroll issues and, yes, her regular tax records are as sloppy,” Armstrong said. “Some people just can’t maintain records or, conversely, keep each and every single piece of paper, valuable or worthless.”
One big question
EA Manasa Nadig, owner of MN Tax and Business Services and a partner at Harris Nadig, in Canton, Mich., has found that most people think if they didn’t receive a 1099-K from side-job platforms, income from that job is tax-free. “Not generally known is that a 1099-K is issued only when sellers exceed $20,000 in gross sales and the total number of transactions exceed 200,” Nadig said. Other trouble spots she’s seen include income and expenses bookkeeping – especially with AirBnB renters with the days rented – and payments of sales tax.
“Probably the single biggest concern to me is whether the side job is really a job and not a hobby, especially if you are talking about filing as sole proprietor,” said Jeff Gentner, an EA in Amherst, N.Y. “If the moonlighting or side hustle is a W-2 situation, then I try my best to make sure they have the proper withholding to cover their tax liability,” he said. “I review and complete the W-4 with them. Many times, at tax preparation time, these smaller W-2s affect the tax liability unfavorably when compared to the withholding.”
“Creating a hobby loss is not a great way of saving taxes, [as the] IRS will cause a lot of grief,” said Brian Stoner, a CPA in Burbank, Calif. “I always get a complete explanation of the side business from the client. Then we discuss what expenses are actually justified for this enterprise and how the client plans to expand the business to avoid hobby loss issues going forward.”
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