One of the biggest challenges associated with a side hustle is paying the right amount of tax on your PhD side hustle at the right time. Understanding your tax due and tax benefits can be even more complicated for PhD side hustles because of the unusual pay structure and benefits that some grad students and postdocs receive.
If you haven’t yet, read last week’s post on the best financial practices for PhD side hustles, and pay particular attention to how to categorize your side hustle (employment, self-employment, neither) because that designation plays a very important role in taxation. The assumption that your side hustle income is much less than your stipend/salary holds here as well. This post is also US-specific.
What Kinds and How Much Tax You Will Owe
The two types of tax on your PhD side hustle that you should be prepared to pay are income tax and FICA tax.
The income tax on your PhD side hustle income will be equal to your side hustle pay for the year multiplied by the marginal tax bracket your primary job tops out in (e.g., 10%, 15%, 25%). The exception is if your side income bumps you into the next higher tax bracket, in which case part of the income will be taxed at your previous marginal tax rate and part at the higher marginal tax rate.
FICA Tax/Self-Employment Tax
The FICA tax rate for each person is 15.3% (12.4% for social security and 1.9% for Medicare; in 2017, social security is not taxed on the portion of your income that exceeds $127,200). If you are an employee, you pay half of that rate (7.65%) and your employer pays half. If you are self-employed, you pay both halves, which is called self-employment tax.
(Graduate students do not pay FICA tax on their stipends because they either fall under the student exemption or their income is not considered wages and is therefore not subject to FICA tax. Postdoc fellows and other fellows also may not pay FICA tax because their income is not considered wages.)
How to Pay Your Tax throughout the Year
If you have tax withholding set up accurately at your primary job, it will only cover the tax due on your primary income. You will additionally need to send the IRS regular payments for the tax on your PhD side hustle income.
If you are an employee in your PhD side hustle, you will file a W-4 with your side employer to have income and FICA tax withheld from that paycheck. The simplest thing to do is claim “0” allowances on your side hustle W-4 and the appropriate amount of allowances on your primary job W-4 (if you have one). For a more detailed calculation, complete the Two-Earners/Multiple Jobs Worksheet on the second page of the W-4.
Further reading: 3 Tax Considerations for Those with Multiple Jobs
If you are self-employed in your side hustle and have tax withheld at your primary job, you can increase your withholding at your primary job to cover the additional tax on your PhD side hustle by filing a new W-4 with fewer allowances and/or an additional dollar amount to be withheld from each paycheck. This is a good strategy if your side hustle income is very regular.
Quarterly Estimated Tax
If you are self-employed with an irregular side income and/or you do not have tax withholding on your primary income, you will probably be required to file quarterly estimated tax.
Quarterly estimated tax payments should be familiar to most PhDs who at some point received non-compensatory income such as from a fellowship or training grant. If you currently receive non-compensatory pay and are making quarterly estimated tax payments, simply adjust your calculations on Form 1040-ES to account for your PhD side hustle income.
For those not currently making quarterly estimated tax payments, the process is relatively straightforward. You use Form 1040-ES (page 8) to estimate your income, tax due, and existing tax withholding for the year. If you will owe more than $1,000 in additional tax and don’t fall into an exception category, you are required to pay that additional tax over four payments taking place in April, June, September, and January. A quick way to take care of this if your tax withholding at your primary job is accurate (you didn’t receive a large refund or owe a lot of additional tax on your return last year) is to calculate your additional income and self-employment tax due for each quarter when the quarter ends. Multiply your income for the quarter by 15.3% plus your marginal tax rate and use that amount as your estimated tax payment.
Further reading: Paying Income Tax throughout the Year
How to Prepare for Your Tax Bill
Whenever you receive side hustle income into your personal bank account (whether that is directly from your client/customer or via your business checking account), you should set aside the appropriate fraction of that income to go toward your tax payments. The best practice for doing this is to set up a separate, dedicated savings account that you solely use for future tax payments. From each bolus of income (or once per month), transfer into your dedicated savings account the fraction of your income that will go toward your income (and self-employment) tax, as calculated above.
Tax Benefits to Having a PhD Side Hustle
One of the best perks of having a PhD side hustle is that it might qualify you for tax benefits not conferred by your primary job, especially if you are a grad student or fellow.
A PhD Side Hustle Is Virtually Always Taxable Compensation/Earned Income
If your primary job gives you non-compensatory pay (i.e., your stipend or salary is not reported on a W-2), you may be ineligible for certain tax benefits that are reserved for people with “taxable compensation” or “earned income.” Examples are Individual Retirement Arrangements (IRAs) and the Earned Income Tax Credit. Therefore, receiving compensation/earned income from a PhD side hustle qualifies you for these tax benefits to some degree.
Further reading: Taxable Compensation or Earned Income
One of the few drawbacks to receiving a fellowship is that fellowship income is not eligible to be contributed to an IRA, which is a tax-advantaged retirement savings vehicle. For fellows, earning just a small side income from a PhD side hustle during calendar years in which you would only have fellowship income can completely reverse this problem. In that case, you can contribute to an IRA up to the amount of your taxable compensation or $5,500 (in 2017), whichever is lower.
Self-Employed People Can Take Business Deductions
If your PhD side hustle is self-employment, even more tax benefits become available to you, such as business deductions. Keeping your personal and business account separate, as discussed in last week’s post, is also extremely helpful for keeping track of business deductions. You should pay for expenses that have solely a business purpose directly from your business checking account.
Of course, not all business expense deductions apply for every type of business, but some of the common ones that freelancers and contractors can take are:
• mileage and gas
• home office
• domain fees and hosting
One step to take when you become self-employed is to diligently track your usage of anything that has both personal and business purposes. You might decide to take a business deduction on the fractional use of those resources.
For example, you should track the mileage in your car, noting the miles used for business. Your internet usage is another deductible expense, again for the fraction of the total time it was in use. If you buy a new computer in a year that you are self-employed, you can deduct part of the cost, but you’ll need to track the fraction of the time that you actually use it for your self-employment work vs. other purposes.
Self-Employed People Can Contribute Even More to Retirement Accounts
Self-employed people are eligible to create retirement accounts for themselves that take the place of a workplace-based retirement account and greatly increase their contribution room above that provided by an IRA.
The additional retirement contribution eligibility is especially beneficial for grad students and postdoc fellows who don’t have access to a workplace-based retirement account (e.g., their university’s 403(b)), and in some cases the self-employment retirement account is a superior alternative to the workplace-based retirement accounts available to PhDs with Real Jobs.
Self-employment retirement accounts come in a few versions, and the best choice is dependent on the number of employees you have, your income, and your desired savings rate. The most common self-employment retirement plans are the individual 401(k), Simplified Employee Pension (SEP), and Savings Incentive Match Plan for Employees (SIMPLE IRA).
How do you pay tax on your PhD side hustle? Has your side hustle conferred any tax benefits that you didn’t already receive through your primary job?