Hobby Meets Hustle: How To File Self-Employment Taxes

Luis Octavio has a talent for DIY — and as the founder and master of #DIYaLaMexicana, he wants to share his passion, inspiration and incredible creations with the world. Of course, that’s not all he hopes to achieve. In our “Hobby Meets Hustle” video series, Luis asks the million-dollar question: “How do I monetize?”

If you have a daydream you’d love to turn into a day job, you’ve probably had the same thought. However, when it comes to turning a hobby into a side hustle, the line between business income and personal finance gets blurry. That can be a real challenge — especially at tax time.

If you’re ready to make money doing what you love, start by watching Luis’s episode of “Hobby Meets Hustle.” When you’re feeling inspired, come back here to learn all about net earnings, income tax and how to file self-employment taxes.

Self-Employment Tax: Learning From Luis

Luis is all about DIY — or as he likes to say, D.I.Güey. Naturally, that do-it-yourself spirit extends to his side hustle, too. Luis is considered self-employed, which means he handles his own net earnings, income tax and business tax return.

But what does that mean for #DIYaLaMexicana — and how can Luis use finance tips and strategies to monetize his hobby? Here’s what you can learn from this creative DIY-er:

Challenges

Transforming a Hobby Into a Side Hustle

Although Luis loves what he does, he knows he still has a lot to do before his hobby generates a steady stream of income. “Right now, the goal is to take this from hobby to side hustle,” he says, “and potentially get it to be a business.”

If you’re in the same boat, the most important thing to think about is structuring your hobby as a professional undertaking. That’s particularly important during tax season, because the Internal Revenue Service (IRS) treats hobbies and businesses as separate entities.

Inventory

Luis says he doesn’t have a lot of inventory — which makes sense, because he pours a lot of time, effort and love into each piece he creates. However, if he wants to generate more income, he’ll need things to sell — and the same is true for your small business or side hustle.

From a financial perspective, gathering inventory creates two basic considerations: costs and savings.

• Costs: You’ll spend money buying or manufacturing your product.
• Savings: You can subtract those expenses from your gross income to calculate net earnings. Only net earnings are taxed — so in some ways, the more you spend, the more you save.

Some expenses related toward your inventory can also be a deductible expense when you file your self-employment income tax return.

Monetizing and Pricing

As Niki Reynolds, TurboTax Expert, points out to Luis, “Putting a price on [your creations] — it’s so subjective. It’s very difficult to identify a number.”

No matter what you build, sell or offer, you’ve probably had the same challenge in monetizing your hobby. There’s plenty to think about, especially if you take your overall income and potential tax deductions into account — but the main thing to remember is that your customers are a valuable resource. Nikki explains this to Luis, saying, “If you’re not sure how to price your items, you could do an auction.” This advice gets Luis’ wheels spinning, and he adds that his followers would appreciate a live stream of the event.

A streamed auction doesn’t just allow Luis’s customers to decide what they’re willing to pay. It also gives Luis valuable insight into what his products are worth in a real-world market and how that translates into income.

Taxes

“How do I set tax things aside? What do I do?”

Luis isn’t the first entrepreneur to ask this question, and he probably won’t be the last. That’s because self-employment and small business taxes can be tricky. The most important thing to know is that when you’re self-employed, you’re responsible for paying certain taxes on your own — taxes that, in traditional work settings, would be taken out of your paycheck by your employer.

Tips

Track and Clarify Costs

“I think my most pressing right now is about expenses,” says Luis. He says he’s currently keeping track of costs in a digital spreadsheet, making notes whenever he remembers. Niki, however, has a better idea.

“Have you thought about isolating your expenses in a separate account or with a separate card?” she asks. That way, business expenses are easier to track — and they won’t interfere with your personal finance management, either.

Report and Deduct Expenses

Once you know what your business expenses are, you can put them to work for you. “As a business owner, you’re entitled to report and deduct all of your expenses on your tax return,” says Niki. For Luis, that includes things like the cost of paint and furniture for DIY projects.

However, there’s more to the story. “If you have a home office, you can take a portion of your rent or mortgage payment, and you can deduct that,” Niki explains. You can also deduct things like automobile expenses, certain types of employee compensation, business insurance and more that are directly related to your business.

Understand Revenue and Pricing Regulations 

One of Luis’ ideas for assigning value to his creations was to have a raffle. Unfortunately, as Niki points out, “Raffling is actually considered gambling.” That means Luis and his business could potentially get into legal trouble.

If you’ve considered a similar solution for pricing your items or creating income, you’re probably feeling a little disappointed. But don’t worry — Niki has a helpful explanation.

“The one thing that makes it gambling is the money component. [To avoid legal trouble], it has to be ‘no purchase necessary,’” she says.

That means you can still come up with fun, creative and engaging ways to involve customers in the pricing process. You just have to understand local and federal regulations around charging money and earning, tracking, and reporting income.

Tax Basics: What To Know About Self-Employment

Now that Luis and #DIYaLaMexicana have inspired you, it’s time to learn what self-employment taxes are all about and what to expect from this important part of business planning.

When Are You Self-Employed?

According to the IRS, you’re self-employed if any of the following apply to you:

• You’re a sole proprietor or independent contractor.
• You’re a member of a partnership carrying on business or trade.
• You’re otherwise in business for yourself, including as a part-time business owner or gig worker.

Keep in mind that you can be self-employed and traditionally employed at the same time. Even if you only had one job or the other for part of the tax year, you’d still need to report all income on your tax return.

What Is The Self-Employment Tax Rate?

As the IRS explains, the self-employment tax rate for 2022 is 15.3%. Notice this is different from the tax rate on traditional income, which ranges from 10% to 37% depending on your tax bracket. That’s because self-employment tax isn’t the same as income tax; you’ll generally need to pay both as a self-employed individual.

What Do Self-Employment Taxes Cover?

Self-employment tax (15.3%) is made up of two things:

• Social Security tax: 12.4%.
• Medicare tax: 2.9%.

When you have a traditional job, your employer withholds Medicare and Social Security tax from your paycheck. When you have a small business or are otherwise self-employed, however, you’re responsible for paying these fees on your own — which is why it’s important to know the difference between self-employment tax and income tax.

Common Mistakes When Filing Self-Employment Tax Returns

Self-employment and small business taxes can be tricky if you aren’t sure what to do, where to look or what to expect. If you want to tackle the tax year like a pro, avoid these common mistakes:

#1: Trying To Do Everything Yourself

As a self-employed individual, you wear a lot of hats — and “tax expert” doesn’t have to be one of them. Instead of scrambling to do research, find all the right numbers and fill out those forms, it’s smart to use top-notch tax software. Automatic data imports and tax deduction search tools are just a few benefits of having the right tax solution at your fingertips.

#2: Failing To Keep Good Records

If you don’t keep good records, it’s easy to get business and personal finances all mixed up. You could also overlook important details that impact your overall income and estimated tax payment — and that could lead to errors on your tax return.

#3: Looking for the Wrong Forms

If this is your first time filing small business and self-employment tax returns, you might be looking for the same forms you got from previous jobs. In most cases, traditional employees receive a W2; meanwhile, self-employed workers may receive a Form 1099-NEC. When filing your annual tax return as someone who is self-employed you will typically need to use a Schedule C and Schedule SE as part of your Form 1040. 

#4: Not Making a Plan

If you don’t do the math ahead of time and make estimated quarterly payments, the size of your tax bill can come as a real surprise. Don’t let taxes take a big bite out of your income; instead, plan ahead and set money aside based on your estimated tax payments.

Self-Employment Tax Time? We’ve Got You Covered

“What would I say to anyone who has a hobby that could potentially be a side hustle?” says Luis. “Just try it!”

If you’re ready to make the leap, remember that you don’t have to DIY your business. At TurboTax, we’re here to help.

Don’t worry about knowing these tax rules. Meet with a TurboTax Live Full Service expert who can prepare, sign and file your taxes, so you can be 100% confident your taxes are done right. Start TurboTax Live Full Service today, in English or Spanish, and get your taxes done and off your mind.