Side income and your taxes: the basics

The first year of a side hustle often ends with a surprise: a bigger tax bill than expected. Not because anything went wrong, but because self-employment income works differently from a paycheck.

This guide covers the basics in plain English, so the money you earn on the side actually ends up moving you toward FIRE.

This is general education, not tax advice. Rules depend on your situation and can change. The IRS links below are the authority; a tax professional can help with your own return.

First: is it a job or a business?

Side income comes in two main forms, and they're taxed differently.

A second job (W-2). If you're an employee, say, part-time at a store or extra shifts on a hospital's payroll, your employer withholds income tax and Social Security and Medicare tax, just like your main job. You'll get a Form W-2.

Self-employment. If you work for yourself, as a freelancer, contractor, tutor, consultant, creator or gig worker, no one withholds anything. You're responsible for income tax and self-employment tax, and you report the business on Schedule C.

Many app-based gigs are self-employment, even if they feel like a job. And some activities are a hobby rather than a business. The IRS lists factors for telling the difference, such as whether you run it in a businesslike way and try to make a profit, and hobby income is still reported (IRS).

The rest of this guide is mainly about self-employment.

Schedule C: income minus expenses

Schedule C is where a sole proprietor reports business income and expenses. The basic idea:

Gross income − business expenses = net profit

Net profit is what's subject to income tax and self-employment tax, not the gross amount you received. Ordinary and necessary business expenses, such as supplies, software, a share of your phone, mileage for business trips, platform fees and professional insurance, can reduce it. The IRS's Publication 334, its tax guide for small businesses, covers which expenses qualify.

Self-employment tax

Employees and employers each pay half of Social Security and Medicare tax. When you're self-employed, you pay both halves.

The IRS says (Topic 554):

• The rate is 12.4% for Social Security and 2.9% for Medicare, 15.3% in total.
• It generally applies to 92.35% of your net earnings from self-employment.
• You usually owe it if net earnings from self-employment are $400 or more.
• You can deduct half of your self-employment tax when figuring adjusted gross income.
• An Additional Medicare Tax of 0.9% can apply above $200,000 for most filers ($250,000 married filing jointly; $125,000 married filing separately).

The Social Security part stops at a yearly cap. For 2026, that wage base is $184,500 (IRS), and wages from your main job count toward it first. Most people with a modest side hustle are well under it.

A made-up example

Say your side business has $10,000 of net profit in 2026.

• Amount subject to self-employment tax: $10,000 × 92.35% = $9,235.
• Self-employment tax: $9,235 × 15.3% ≈ $1,413.
• Half of that, about $706, is deducted when figuring your adjusted gross income.

You'd also owe regular income tax on the profit at your own tax rate, and possibly state tax. How much to set aside depends on your bracket, state and deductions. A tax professional or the IRS's Form 1040-ES worksheet can help you estimate.

Estimated taxes

Because nothing is withheld, the IRS expects you to pay during the year.

• Who: individuals, including sole proprietors, generally have to make estimated payments if they expect to owe $1,000 or more when they file (IRS).
• When, for 2026: April 15, June 15, September 15, and January 15, 2027 (IRS Pub 509).
• How: Form 1040-ES has a worksheet. Payments can be made online through the IRS.

Avoiding the underpayment penalty

You generally avoid a penalty if your withholding and estimated payments add up to at least the smaller of 90% of this year's tax or 100% of last year's tax (IRS Topic 306). If last year's adjusted gross income was over $150,000 ($75,000 if married filing separately), the prior-year figure is 110% instead (IRS Pub 505). Timing matters too: the payments have to be made by each installment's due date. Catching up with one large late payment can still leave a penalty for the earlier quarters you underpaid (IRS). Tax withheld from a paycheck is generally treated as paid evenly through the year, which is one reason the W-4 route below can help (IRS Pub 505).

Or raise your withholding

If you also have a paycheck, the IRS notes you can ask your employer to withhold more by filing a new Form W-4 (IRS). For people with a modest side hustle, that can be simpler than quarterly payments.

The 1099 forms

You may get forms reporting what you were paid. For payments made in 2026:

• Form 1099-NEC: businesses generally report payments of $2,000 or more to a non-employee for services, up from $600. The $2,000 figure is set to be adjusted for inflation starting in 2027 (IRS Pub 1099).
• Form 1099-K: payment apps and online marketplaces generally don't have to file one unless payments to you exceed $20,000 and 200 transactions in the year (IRS).

Important: these are reporting thresholds, not tax thresholds. Income is taxable whether or not you receive a form.

Records to keep

Simple habits go a long way:

• A separate bank account (and card) for the side business.
• Every payment in, with the date and who paid.
• Receipts for expenses, with a note on the business purpose.
• A mileage log if you drive for the business.
• Copies of 1099s and your estimated tax payments.

Many people also move a fixed percentage of every payment into a separate "tax" savings account the day it arrives, so the money's there when a payment is due.

The FIRE upside: retirement accounts

Self-employment income can open up retirement accounts beyond what your job offers:

• A Solo 401(k) lets you contribute as both "employee" and "employer," within combined limits. Your employee deferrals are shared with any 401(k) or 403(b) at your main job: $24,500 total for 2026 (IRS), though employer contributions can still go in (IRS).
• A SEP plan is funded by employer contributions, and for the self-employed they're figured on net earnings using a special calculation. If the SEP-IRA account allows it, you can also make regular IRA contributions to it, under the normal IRA limits (IRS).

Both can lower taxable income now and grow your FIRE savings. FIRE in the trades explains how each works.

In early retirement

Side income doesn't stop mattering after you leave your main job. It can change how much you pay for marketplace health insurance, and, if you claim Social Security before full retirement age, the earnings test can temporarily withhold benefits. Side hustles and passive income: a realistic guide covers both.

Next step

Once taxes are set aside, see how much faster the rest could get you to FIRE.

Try the Freedom Date calculator →

Looking for ideas? Read Side hustles that use the skills you already have.