Taxes on Side Income

The first tax season after starting a side business surprises many people. Nobody withheld anything from the side income, it is taxed at the top of their bracket, and on top of income tax there is a second tax most employees have never had to think about. This chapter explains the two federal taxes on self-employment profit, how much to set aside, how quarterly estimated payments work and how to avoid the penalty, which costs you can deduct, and when a business structure such as an LLC or an S corporation changes the picture. The rules below are federal rules for 2026; states add their own.

Two taxes on the same profit

When you work for yourself, the IRS treats your net profit (income minus allowable business expenses, reported on Schedule C for a sole proprietor) as earnings. It is taxed twice over, in two different ways.

Self-employment tax. As an employee, you pay 7.65% of your wages in Social Security and Medicare tax, and your employer pays another 7.65%. When you are self-employed you are both, so you pay the full 15.3%: 12.4% for Social Security and 2.9% for Medicare. The tax applies to 92.35% of your net earnings (a rule that mirrors the employer's share not being taxed as wages), so the effective rate works out to about 14.1% of profit. It is owed once net earnings from self-employment reach $400 for the year, and it is owed even if you pay no income tax at all.

Two details matter for people with a day job. The Social Security part applies only up to $184,500 of combined wages and self-employment earnings in 2026, so someone whose salary is already above that figure pays only the 2.9% Medicare part on side profit. And self-employment tax is not wasted: it earns Social Security credits and counts toward your future benefit.

Income tax. The profit is also added to your other income and taxed at your ordinary rates. Because it sits on top of your salary, it is taxed at your highest bracket, not your average rate. You may deduct half of your self-employment tax when working out income tax, which slightly softens the combined bite.

How side income lands in your bracket

The example below compares someone's federal income tax on wages alone with the same wages plus side profit, using 2026 brackets and the standard deduction for a single filer.

On wages alone, income tax is $4,780, and the top bracket reached is 12.0%. With side profit added, bringing total income to $73,000, income tax rises to $7,230 and the top bracket reached is 22.0%. Part of the side profit filled the rest of the 12% bracket (which ends at $50,400 of taxable income for a single filer in 2026) and the rest spilled into the 22% bracket. Notice that the share of total income going to income tax barely moves, from 8.2% to 9.9%, while the tax on the side profit itself is far higher than either average.

This illustration treats all income like wages and leaves out the half-of-self-employment-tax deduction and the qualified business income deduction below, so it slightly overstates the income tax. Self-employment tax comes on top of it. The side hustle tax calculator combines both taxes for your own wages and profit.

A practical set-aside. Adding your top federal bracket, about 14% for self-employment tax, and your state's rate gives a percentage of each payment to move into a separate tax account the day it arrives. Because of the deductions, this usually comes out slightly above what you will owe, which is the safer direction to be wrong in.

The qualified business income deduction

Many sole proprietors, partners and S corporation owners can deduct up to 20% of their qualified business income when working out income tax. Below a taxable income of $201,750 ($403,500 for married couples filing jointly) in 2026, the extra limits based on the type of business and the wages it pays generally do not apply. Above those figures the deduction can shrink or disappear for some service businesses, such as consulting, health, law and financial services.

Two limits are worth knowing. The deduction reduces income tax only, not self-employment tax. And it is also capped at 20% of taxable income excluding net capital gains, which matters when other deductions are large. The 2025 tax law extended this deduction beyond its original end date; check IRS guidance if your income is near the thresholds.

Quarterly estimated tax and the penalty

The US tax system is pay-as-you-go. Employers withhold from wages; on self-employment income, you pay yourself through estimated tax payments. You generally need to make them if you expect to owe $1,000 or more for the year after withholding and refundable credits. The 2026 due dates are April 15, June 15 and September 15 of 2026, and January 15, 2027.

You avoid the underpayment penalty if your withholding and estimated payments together reach the smaller of:

• 90% of this year's tax, or
• 100% of last year's tax, rising to 110% if last year's adjusted gross income was above $150,000.

The prior-year rule is the simplest for a growing side business: last year's tax is a known number, so paying a quarter of the required percentage each due date protects you even if this year's income jumps. You will still owe the balance in April, so keep setting money aside.

If you also have a job, there is an easier route. Ask your employer to withhold more by filing a new Form W-4 with an extra amount per paycheck. Withholding is treated as paid evenly through the year regardless of when it actually happened, so a late-year increase can cover a shortfall from earlier quarters that estimated payments could not. The quarterly estimated tax calculator shows what to pay on each date and what a missed one would cost. Most states with an income tax have their own estimated payment rules.

Deductions: what you can subtract

You may deduct business expenses that are ordinary and necessary for your trade, which lowers both income tax and self-employment tax. Common ones for freelancers:

• Equipment and software used for the business, including the business share of a computer or phone.
• Home office, if part of your home is used regularly and exclusively for the business. A spare bedroom that is also a guest room does not qualify. IRS Publication 587 gives two methods: actual expenses in proportion to the space, or a simplified method that uses a fixed rate per square foot for up to 300 square feet.
• Business use of a car, either actual costs or the IRS standard mileage rate, with a log of business trips.
• Professional costs: insurance, accounting, legal fees, training that maintains or improves skills in your current business, marketplace and payment fees.
• Health insurance premiums for yourself and family, as an adjustment to income, but not for any month in which you were eligible for an employer-subsidized plan, including through a spouse.
• Retirement contributions to a plan for the self-employed, covered in the next chapter.

Records are what make deductions hold up. Use a separate bank account and card for the business, keep receipts, and note the business purpose of anything that could look personal.

Clients may send a Form 1099-NEC and payment platforms a Form 1099-K, but the income is taxable whether or not any form arrives.

Hobby or business, and which structure

Hobby or business. The IRS distinguishes an activity carried on to make a profit from a hobby, looking at factors such as whether you run it in a businesslike way, keep records, depend on the income, and change methods to improve profitability. Hobby income is still taxable, but under current law hobby expenses cannot be deducted, so treating a real business like a business matters.

Structure. A sole proprietorship exists automatically when you start working for yourself. A single-member LLC is a state-law entity that can limit personal liability for business debts and claims if it is kept genuinely separate, but by default the IRS taxes it exactly like a sole proprietorship. An S corporation election changes the tax: the owner takes a reasonable salary through payroll, which carries payroll taxes, and further profit can be paid as distributions that do not. It also adds payroll costs, a separate return and often state fees, so it tends to help only once profit is comfortably above a reasonable salary for the work. That decision is worth making with a tax professional.