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How Side Income Impacts Your Tax Return

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Side income can be a great way to reach financial goals faster, pay down debt, or explore a new passion — but it also changes your tax situation. Whether you’re freelancing, driving for a rideshare app, selling products online, or renting out a room, the IRS considers side earnings taxable income. Understanding how to report it properly helps you avoid penalties while maximizing deductions.

The first rule is simple: if you earn money, it’s taxable. Even if it’s a small amount or a one-time payment, it needs to be reported. Many side earners assume that if they don’t receive a 1099 form, they don’t need to report the income — but that’s not the case. The IRS requires you to report all income, regardless of whether it’s officially documented by a third party.

Freelancers and gig workers typically receive a Form 1099-NEC or 1099-K, depending on the platform or client. These forms report nonemployee compensation and payment app transactions, respectively. Keep in mind that starting in 2025, the 1099-K reporting threshold is $5,000, but you’re still responsible for reporting smaller amounts even if no form is issued.

With side income comes the responsibility of paying self-employment tax, which covers Social Security and Medicare contributions typically withheld by employers. Currently, the self-employment tax rate is 15.3%, though half of that amount can be deducted on your return. Setting aside a portion of each payment — typically 25–30% — helps cover both income and self-employment taxes.

The good news? Side work comes with plenty of potential deductions. You can often deduct business-related expenses such as internet costs, software subscriptions, mileage, and even a portion of your home office if you meet IRS guidelines. Keeping detailed records of these expenses throughout the year can significantly reduce your taxable income.

To stay compliant and organized, use separate bank accounts for your side business and personal finances. This simplifies bookkeeping and provides a clear audit trail. You may also need to make quarterly estimated tax payments to avoid underpayment penalties — something your accountant can help calculate based on your income pattern.

Even if your side income starts small, reporting it accurately builds good financial habits and establishes a clear record of earnings. That record can help you qualify for loans, plan for retirement, or even grow your side hustle into a full-fledged business later on.

In short, side income can be a great financial boost — but it comes with added tax responsibility. With a little planning and good documentation, you can enjoy the extra earnings without the year-end surprises.

What the IRS Is Focusing on in 2026

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Sorenson & Company, CPA - Sandy UTIRS enforcement priorities continue to evolve, and in 2026, the agency remains focused on accuracy, reporting transparency, and compliance consistency. While most businesses aim to follow the rules, certain patterns and errors tend to attract closer attention during reviews or audits.

One major area of focus is income reporting. Discrepancies between reported income and information returns such as 1099s or other third-party documentation often trigger questions. Businesses that receive income from multiple sources must ensure all revenue is accurately reported and properly categorized.

Another ongoing area of scrutiny involves deductions. While deductions are a legitimate and important part of tax planning, exaggerated or poorly documented expenses raise red flags. Businesses should ensure that deductions are reasonable, directly related to operations, and supported by clear records.

Common areas the IRS continues to monitor include:

  • Inconsistent income reporting across tax forms
  • Excessive business expense deductions relative to revenue
  • Improper classification of workers as contractors instead of employees
  • Payroll tax filing and payment errors
  • Home office deductions that do not meet usage requirements

Technology and data matching have also become more sophisticated. Automated systems allow the IRS to compare filings more efficiently, increasing the likelihood that inconsistencies are identified quickly. This makes accurate reporting and documentation more important than ever.

Good recordkeeping remains one of the strongest defenses against compliance issues. Businesses that maintain organized financial records, reconcile accounts regularly, and document key decisions are better prepared if questions arise. Addressing potential issues early can prevent small errors from becoming larger problems.

Understanding IRS focus areas helps businesses take a proactive approach to compliance. By reviewing filings carefully, maintaining accurate records, and seeking guidance when needed, businesses can reduce risk and operate with greater confidence in today’s regulatory environment.

What Is Your Most Valuable Asset?

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Woman working on laptop online, checking emails and planning on the internet while sitting in an office alone at work. Business woman, corporate professional or manager searching the internetYour most valuable asset isn’t your real estate or the tech stocks you bought in the 90s that have done well. It isn’t even your business per se. Your most valuable asset is you — specifically your ability to run a profitable company and make money.

Are you protecting that asset from the risk that a disabling illness or accident might prevent you from working? If you don’t have disability income insurance, you’re not protected.

What Are the Odds?

People generally think the odds of becoming disabled are low. But the numbers say otherwise: More than one in four 20-year-old workers become disabled before reaching retirement age. Here’s another reality check: Serious accidents are not the leading cause of long-term disability; chronic conditions are. Muscle and bone disorders (such as a back disorder or joint or muscle pain) are responsible for more than one in four disabilities.

How Long Could You Go Without an Income?

Even a short period of disability could be devastating. The average group long-term disability claim lasts 2.6 years. Even if you have reserves you 3 could tap, your personal finances would take a hit. If and when you were able to start earning an income again, you might have to start all over.

What Would Happen to Your Business?

Your involvement is vital to your company’s financial success. If you’re unable to work, you might have to hire someone to take your place and borrow money to pay the bills until you’re back on the job. Bottom line? If you’re sidelined by a long disability, it could jeopardize the success or even the survival of your business.

What Can You Do?

Call your financial professional to review and discuss this important issue.

Does Your Risk Tolerance Need a Realignment?

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Investor information graph. Careful forex trader make money revenue, sell stock indicator with diagram profit information crypto analysis professional marketing vector illustration of investment graphMarket volatility. A change in your time horizon. Different goals. All these things can affect the amount of risk you feel comfortable taking with your investments. Your ability to tolerate risk influences the investment choices you make and may have a significant impact on your success in achieving your financial objectives. Periodically revisiting your risk tolerance is an important step in the portfolio review process.

A Moving Target

Your feelings about risk may change depending on what the markets are doing. During a prolonged period of market volatility, you may find your comfort level dropping, even if you previously thought you had a high tolerance for risk. If you’re a conservative investor, an extended market upswing may have the opposite effect, encouraging you to take on additional investment risk. In either case, basing investment decisions on market behavior instead of a well-thought-out investing strategy isn’t the best plan. Instead, take time to reassess your feelings about risk. If they’ve truly changed, adjust your strategy going forward to reflect the changes.

More Than a Feeling

How much money could you afford to lose if investment values dropped significantly? Your ability to accept risk also depends on your financial circumstances and your time horizon for tapping your assets. If investment losses would leave your finances in jeopardy and you have a relatively short time frame before you’ll need your money, your capacity for taking risk may be limited. Make sure you consider your risk capacity in your review.

A Realistic View

A long period of either strong or weak market performance may convince you that the current trend will continue indefinitely. Perceived risk is how much risk you think an investment holds. However, your perception of an investment’s risk might not match its actual risk. In that case, you could be taking more or less risk than you should to remain within your comfort zone and still reach your goals.

Your financial professional can help you reassess your risk tolerance along with the level of risk in your portfolio.

7 Tax Credits for Your Small Business

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Business People Meeting using calculator,notebook,stock market chart paper for analysis Plans to improve quality next month. Conference Discussion Corporate ConceptLet’s talk about tax credits – what they are, how they differ from deductions, and which can benefit your small business.

What are tax credits?

A tax credit is a dollar-for-dollar reduction of one’s tax liability, reducing the amount of tax owed. So, a tax credit of $300 lowers your bill by $300.

Tax deductions work differently. Let’s see how tax credits and tax deductions differ.

How do tax credits differ from tax deductions?

Unlike tax credits, which are dollar-for-dollar reductions in taxes, tax deductions decrease one’s taxable income. That means only a percentage of each dollar deducted is taken off your income tax. The percentage depends on your tax bracket and the rate at which your income is taxed.

How do you know which tax credits apply to your business?

General business tax credits are calculated individually from a list of tax credits published by the IRS. Each one requires its own form. Once those are filled out, they are tallied. Once the general business tax credit for the year is determined, it is filed on Form 3800 with your tax return.

Now let’s discuss some tax credits that benefit small businesses.

What are some tax credits that benefit small businesses?

1. Family and Medical Leave Credit (FMLC)

Family and medical leave is taken when an employee must be away from work due to an event such as:

  • the birth of a baby
  • a severe illness of an immediate family member
  • a serious health condition that prevents the employee from working

The tax credit for this type of leave is applicable when the employer:

  • has a written policy in place stating they will provide family and medical leave.
  • provides paid leave to employees for family or health-related reasons for at least two weeks in a given year.
  • pays a minimum of half the employee’s earnings

The employee must have been on the payroll for at least one year for an employer to claim the credit, which is between 12.5 and 25 percent of the employee’s pay.

You will use IRS Form 8994, the Employer Credit for Paid Family and Medical Leave to claim this credit.

2. Child Care Credit

This credit is part of the general business credit. It may be claimed any time within three years from the due date of your return on either an original or amended return. The credit is 25 percent of the qualified childcare facility expenditures plus 10 percent of the qualified childcare resource and referral expenditures paid or incurred during the tax year, limited to $150,000 per tax year.

Qualified expenditures are:

  • The cost of acquiring, building, or expanding a property to be used as part of a qualified childcare facility, is the depreciable (or amortizable) property and is not part of the principal residence of the business owner or any employee.
  • Operating expenses of a qualified childcare facility of the taxpayer
  • The expense paid to a qualified childcare facility that provides childcare to employees.

For this tax credit, fill out IRS Form 8882, Credit for Employer-Provided Child Care Facilities and Services.

3. Health Insurance Credit

Employers who pay health insurance premiums for employees can redeem a tax credit for up to 50 percent of those expenses. However, specific criteria must be met. For example, this credit only applies to companies with less than 25 full-time employees. The employer must pay at least half the employees’ health insurance premiums. Further, the average payroll cannot be more than $56,000 (as of 2022). Also, remember that your business must purchase health coverage through the Small Business Health Options (SHOP) program.

If your business meets these criteria (and all others required by the IRS), use Form 8941, Credit for Small Employer Health Insurance Premiums.

4. Employee Pension Plan Credit

The Employee Pension Plan Credit is worth up to $500, or 50 percent of your business startup costs. It can be claimed for the first three years of your plan. To qualify for this credit, your company must have fewer than 100 employees, each receiving a minimum of $5,000 in compensation. You can’t have had a 401(k) or other qualifying retirement plan for the previous three years. Lastly, you must plan to start a pension plan for your employees.

To claim this credit, use IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs.

5. New Clean Vehicle Credit

This tax credit applies to plug-in electric vehicles (EV) or fuel cell vehicles (FCV). You could receive a credit of up to $7,500 for either of these types of cars. The Inflation Reduction Act of 2022 changed the rules for this credit for vehicles purchased from 2023 to 2032.

To qualify, the vehicle must be for your own use and not for resale and must be used in the United States. Further, your modified adjusted gross income (AGI) may not exceed $150,000. The type of vehicle the credit applies to can be found on the IRS website. (Note: battery and vehicle weight specifics and other qualifying criteria exist.)

To claim the credit, file Form 8936, Qualified Plug-in Electric Drive Motor Vehicle Credit (Including Qualified Two-Wheeled Plug-in Electric Vehicles), with your tax return. You will need to provide your vehicle’s VIN.

6. Disabled Access Credit

You might be eligible for this credit if you spent money making your business more accessible to people with disabilities. To determine the official IRS definition of “accessible” which is broad, consult the instructions for IRS Form 8826. That is where you will find qualifying expenses.

The credit covers 50 percent of expenses up to $10,250 after the first $250. The maximum tax credit is $5,000. To claim this credit, use IRS Form 8826, Disabled Access Credit.

7. Work Opportunity Tax Credit (WOTC)

This credit is targeted at employers who hire individuals from specific groups, including (but not limited to):

  • Veterans
  • Ex-felons
  • Summer youth employees
  • SNAP recipients
  • SSI recipients
  • Long-term unemployment recipients

The WOTC is a one-time tax credit for newly hired individuals. To claim this credit, fill out IRS Form 8850, Pre-screening Notice, and Certification Request.

Of course, you can discuss these and many other tax credits that may benefit your small business with your qualified accountant or CPA.

Record Retention — The “Paper” Trail

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As plan sponsors are well aware, the pension law (ERISA) includes specific reporting and disclosure obligations with respect to qualified retirement plans. A lesser known fact is that ERISA also has specific requirements regarding the retention of plan records. Below we answer questions you and other plan sponsors may have about retaining records and the importance of a record retention policy.

Why would we need a record retention policy? A retirement plan, by its very nature, generates a large amount of documentation. Some records should be retained indefinitely. Others may be disposed of in time. Having an established document retention system that allows plan records to be reviewed, updated, and preserved or disposed of in an organized fashion fosters good administration and helps the plan comply with pension law. Such a system can also make required documents readily accessible for IRS review, if requested.

Who is responsible for retaining plan records? Under ERISA, the plan administrator — which is often the plan sponsor — is ultimately responsible for maintaining the plan’s records.

What records do we need to keep? The list is long. First, you need to keep all records that support the information included in your plan’s Form 5500 filings and other reports and disclosures. These supporting documents essentially include whatever records a government auditor might need to verify the accuracy of the original report or disclosure. You also need to keep records used to determine eligibility for plan participation and any plan benefits to which employees and beneficiaries may be entitled. Records include:

  • The original signed and dated plan document, plus all original signed and dated plan amendments
  • Employee communications including summary plan descriptions (SPDs), summaries of material modifications (SMMs), and anything else describing the plan that you provide to plan participants
  • The determination, advisory, or opinion letter for the plan
  • All financial reports
  • Copies of Form 5500
  • Payroll records used to determine eligibility and contributions, including details supporting any exclusions from participation
  • Evidence of the plan’s fidelity bond
  • Documentation supporting the trust’s ownership of the plan’s assets
  • Documents relating to plan loans, withdrawals, and distributions
  • Nondiscrimination and coverage test results
  • Employee personal information, such as name, Social Security number, date of birth, and marital/family status
  • Employment history, including hire, termination, and rehire dates (as applicable) and termination details
  • Officer and ownership history and familial relationships
  • Election forms for deferral amount, investment direction, beneficiary designation, and distribution request
  • Transactional history of contributions and distributions

How long do we need to keep the records? Generally, you should keep records used for IRS and DOL filings for at least six years after the filing date. Retain records relevant to the determination of benefit entitlement indefinitely (basically, permanently).