More Income, More Tax Considerations: What to Know Before Taking on Extra Work

Whether you pick up a second job, start freelancing, or turn a side project into an additional source of income, earning more can be a great opportunity. But additional income can also change your tax situation.

Understanding how that income will be reported and taxed can help you plan ahead and avoid an unexpected bill when it is time to file your return.

Start by Understanding How You Are Being Paid

Not all income is treated the same for tax purposes. One of the first things to understand when taking on additional work is whether you are being paid as an employee or an independent contractor.

Employees generally receive a Form W 2, with their employer withholding applicable income and payroll taxes from each paycheck. Independent contractors typically receive a Form 1099 and are generally responsible for managing their own tax obligations.

Knowing how you will be classified before beginning the work can help you understand what to expect and how much of your additional income you may need to set aside.

A Second Job Can Affect Your Withholding

Having taxes withheld from your paycheck does not necessarily mean enough is being withheld.

When you work for more than one employer, each employer may calculate withholding based primarily on the income you earn from that job. Once all of your income is combined on your tax return, your overall tax liability may be different than expected.

If you add another job or income source during the year, it may be a good time to review your withholding and determine whether an adjustment should be made.

Independent Contractors Have Additional Responsibilities

Freelance and contract work can provide greater flexibility, but it also places more responsibility on you when it comes to taxes.

Because taxes are generally not withheld from contractor payments, you may need to plan for income taxes as well as self employment taxes. If your contract work becomes a consistent source of income, estimated tax payments may also become part of your tax planning strategy.

Rather than waiting until tax season, setting aside money as you earn it can make those obligations much easier to manage.

Keep Good Records From the Beginning

If you are earning income from freelance work or a side business, keeping accurate records is important.

Consider separating business activity from your personal finances and consistently tracking income and eligible business expenses. Good record keeping can make tax preparation easier while helping ensure you have the information needed to identify potential deductions and accurately report your income.

Make Extra Income Part of Your Tax Planning

Additional income can be a valuable way to strengthen your financial position, but it should also be incorporated into your overall tax strategy.

A new job, freelance project, or growing side business may affect your withholding, estimated payments, deductions, and overall tax liability. Reviewing those changes during the year gives you more time to make adjustments rather than discovering the impact when your return is prepared.

If your income has changed this year, the team at Somich & Associates can help you understand the potential tax impact and determine what steps may make sense before year end.