Picking up a side gig can be a great way to make some more money and give some breathing room to your budget, particularly during inflationary times. But one thing that many workers overlook when it comes to their side gig income is the taxes they may have to pay.
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If you neglect to work taxes into your budgeting, you may still find you have an income shortfall even after you put in the hours working your side gig. To help you avoid falling into this predicament, here's a look at how you can avoid paying taxes on your side gig - or at least reduce them.
Maximize Your Deductions
Although you can reduce your taxes by cutting your side gig income, that's not a good tradeoff. However, you can legally reduce your taxable income by taking allowable deductions against it. Here are some of the common deductions you may be able to take while working a side gig:
Tools and equipment
Home office expenses
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Bear in mind that these items are not automatically deductible. They must apply directly to your side gig and be ordinary and necessary. For example, if you pick up a side gig as a Japanese tutor, you can't write off the classes you're taking to become an architect or your monthly subscription to Car & Driver magazine. If you have any doubts about which expenses may qualify - particularly for the home office deduction, which is often a red flag for an audit - be sure to speak with a tax advisor.
Contribute to Retirement Plans
Contributing to a retirement plan is one of the best ways to lower your taxable income without reducing the actual money you earn. In fact, by working a side gig, you may be able to completely eliminate the amount of your taxable income, depending on the type of plan you use.
The reason: As a side gig worker, you are technically running your own business. If you set it up correctly, you can open a retirement plan that applies only to self-employed individuals, such as a SEP-IRA or a solo 401(k). Both of these plans offer you the opportunity to contribute as much as 100% of your earned income from that side gig into the plan, thereby reducing your taxable income for that work to zero as well.
Of course, if you contribute all of your earnings to your self-employed retirement plan, there won't be anything left for you to spend on things like your mortgage, rent or personal consumption. But you'll also be able to sock away all of that money for your retirement, and you won't pay any taxes on it either.
These types of plans have their own limitations though. For example, in 2022, you can contribute only up to $6,000 into a SEP-IRA, no matter how much you make. However, that still allows you to earn an average of $500 per month from a side gig and invest it all into your retirement account without paying any tax. If you earn more than that, a solo 401(k) might do the trick for you, as it has a much more generous contribution limit - up to $20,500 in 2022. Additionally, you can make an employer contribution - as you are both employee and employer - of up to 25% of your compensation.
The Bottom Line
The only way to legally avoid paying taxes on side gig income is to either earn a very small amount or to reduce the taxable portion through a variety of allowable deductions. As interpreting the size and legality of various deductions can get complicated, it's recommended to consult a tax advisor if you take on a side gig that amounts to anything more than a few hundred dollars of income.
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This article originally appeared on GOBankingRates.com: How To Avoid Paying Taxes on Side Gig Income