How Do I Legally Protect My Side Hustle?

With many people struggling to keep up with inflation and insufficient wage growth, side hustles are becoming increasingly common. In fact, MarketWatch, a website that provides business news, financial information, and stock market data, reported in May 2024 that 54% of Americans took on part-time jobs during the past year to supplement their primary incomes.

A job on the side might help cover necessary expenses or provide some extra fun money, but there are some financial and legal implications you’ll need to consider if you’re thinking of getting started or already working in one. Legal obligations concerning side work must be taken seriously, as there can be serious consequences if you ignore them. Whether you’re interested in pet sitting, online tutoring, consulting, food delivery, or landscaping, take a little time to learn about keeping your side hustle on the right side of the law.

A side hustle is generally considered to be an activity outside of a person’s full-time job that provides supplemental income. In some cases, however, it can be tricky to differentiate between a hobby and an activity you do in addition to your “real” job. Let’s take a closer look at that concept and see what the IRS has to say about it.

Is Your Side Job a Hobby or Business?

It’s not unheard of for a hobby to turn into a business on the side, often unintentionally. One day you’re making bead bracelets and giving them as birthday presents to family members and friends, and the next day the owner of a craft store in your town asks if you’d like to sell the bracelets in her shop. Suddenly, your hobby has the potential to become a business—perhaps a lucrative one.

The IRS has something to say about the difference between a hobby and a business, and more to say about any money you earn from them. While you might think of earnings from a side gig as just extra cash, the IRS views it as income that must be reported on your tax returns.

According to the IRS, the main difference between a hobby and a business is that a business actively attempts to generate a profit while a hobby does not.

The IRS also offers these guidelines for determining whether an activity is a business or a hobby:

• Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records
• Whether you have personal motives in carrying on the activity, such as general enjoyment or relaxation
• Whether the time and effort you put into the activity indicate that you intend to make it profitable
• Whether you depend on income from the activity for your livelihood
• Whether any losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business)
• Whether you or your advisors have the knowledge needed to carry on the activity as a successful business
• Whether you were successful in making a profit in similar activities in the past
• Whether the activity makes a profit in some years and, if so, how much profit it makes
• Whether you can expect to make a future profit from the appreciation of the assets used in the activity

If you don’t know whether your side hustle activities are considered a business venture, talk to your accountant and get an expert’s opinion. And remember that whether you’re participating in a hobby or a business, if it generates $400 or more in net income, you’ll need to file a tax return.

Side Hustle Deductions

The good news from the IRS is that you’re able to deduct certain expenses from your side business, which can help reduce your taxable income. The IRS defines a business expense as one that is both ordinary and necessary, which means you can deduct a portion of your car maintenance or mileage if you’re driving for a rideshare company, or the cost of your materials, home office space, and shipping costs if you’re selling handmade jewelry on Etsy.

Some of the most common deductions associated with side hustles include the following:

• Business-related car mileage
• Tools and equipment necessary for the job
• Training and educational expenses incurred while building the skills needed for the side hustle
• Dues and subscriptions paid for memberships to business associations
• Home-based business expenses based on the size of dedicated office space and amount of business usage, including a portion of the mortgage or rent, utility bills, phone, and internet
• Startup costs such as legal fees, market research, conducting surveys, marketing fees, and organizational expenses
• Office equipment, including furniture, computers, and printers

It’s important to note that if you’re running your side job as a genuine business to take advantage of IRS deductions, the impetus is on you to take the appropriate legal steps to register the business and comply with all regulations pertaining to it.

Making Your Extra Job a Real Business

If you’re earning money from an extra job, regardless of what type of work you’re doing, you are—by default—operating a business. You don’t have to file documents with a state agency or hang a sign above your door. If you’re earning money from selling a product or service, you’re in business and responsible for reporting income to the IRS. If you’re operating on your own, you’re, by default, considered to be running a Sole Proprietorship. If you work with one or more partners, you’ve got a General Partnership.

Many people operate as Sole Proprietors. In fact, Sole Proprietorships account for 76.2% of all businesses, according to the U.S. Census Bureau. Let’s take a closer look at Sole Proprietorships, General Partnerships, and other business entities you may want to consider for your side business.

 Sole Proprietorships and General Partnerships

Sole Proprietorships and General Partnerships are popular because they’re easy to establish, have minimal compliance requirements, and taxes are simple because they’re passed through and reported on your personal tax return. Unless you want to call the business something other than your legal name or names, you don’t need to file any paperwork to start a Sole Proprietorship or General Partnership. If not using your legal name, you’ll need to file a Doing Business As, or DBA, also known as a fictitious name, with your state’s Office of the Secretary of State or comparable agency. You also may need to obtain a Federal Tax ID number before you can open a business bank account, which is highly recommended as it helps keep business and personal finances separate. And a General Partnership would benefit from a partnership agreement that details the division of ownership and duties.

One big problem with a Sole Proprietorship or General Partnership, however, is that there is no legal separation between the business and the business owner. That means if the business incurs debt it can’t repay or is sued, the owner can be held personally responsible. And that puts personal assets, including savings, real estate, cars, and other property at risk.

Limited Liability Company

You can get around the issue of personal liability by forming a Limited Liability Company (LLC), which is considered a separate entity from its owners and protects personal assets in the event of debt or legal action. If you’re on your own you’ll form a Single-Member LLC, and if you have one or more partners, you’ll have a Multi-Member LLC.

An LLC must be registered with the state. You’ll need to pay a fee to file Articles of Organization with the Office of the Secretary of State, and you’ll encounter ongoing fees necessary to cover costs such as an annual franchise tax, business license renewals, and filing annual reports. While that all can sound daunting, once an LLC is up and running the compliance regulations are fairly simple. If you’re serious about your side hustle and concerned about protecting your personal assets, forming an LLC is highly advisable.

C Corporation

If you think your side hustle has the potential to become a substantial business venture or if you’re looking to attract investors, incorporating is an option worth exploring. A corporation is known as a C Corporation unless it meets certain qualifications that enables the IRS to give it special tax status and classify it as S Corporation. C Corporations are the most common type of Corporation.

A Corporation is a legal entity separated from its owners by a “corporate veil.” Business owners are considered employees of the Corporation, which gives them a substantial degree of personal liability protection. That means if the business is sued or incurs debt it can’t repay, only corporate assets are at risk, not the personal assets of owners.

A Corporation must be registered with the state and operate under state laws. As a state-formed entity, C Corporations are required to file Articles of Incorporation, create corporate bylaws, form a board of directors, hold regular board meetings, and pay all state-required fees to maintain good standing.

While there are significant advantages to forming a business as a Corporation, many entrepreneurs are put off by what is known as double taxation. A Corporation must pay corporate taxes—currently a flat rate of 21%—on its earnings before any profits can be distributed to its owners, who are called shareholders. Those shareholders must then pay personal income tax on the profits they receive, resulting in double taxation.

Other Legal Implications to Consider

In addition to reporting income and complying with tax regulations, there are some other legal issues that could put your side gig at risk if ignored.

Whether you’re operating your side business as a Sole Proprietorship, Partnership, LLC, or Corporation, you may be required to get business licenses and/or permits to operate it legally. Business licenses can be required at the local, state, and federal levels, so you’ll need to do some research to find out what you need. The license you’re most likely to need is a local business operating license, which is granted by your local government. If you’re selling food, offering personal training services, or doing nails or hair, you’re likely to need some sort of health license or permit. If your side hustle is a plumbing or electrical business, you may need a business license specific to your occupation. And if you operate a business from your home, chances are you’ll need a home occupation permit. Regulations vary among municipalities, so check your city, township, or county codes to see what’s required.

Something else to consider is your day job and any limits your employer or employment contract might impose on your side hustle. Be aware of noncompete clauses or other restrictions you may be subject to and be sure there are no policies that make extra jobs off limits. Do not under any circumstances bring work from your side gig to your day job, and don’t use any company equipment to work on it. Also, make sure there is no possibility of your side business drawing customers from your day job. If you’re thinking of starting a side hustle and don’t know how your employer will react, it’s best to discuss your planned venture with a manager or someone from the HR department.

If your part-time work is based on a certain brand, such as a logo, business name, symbol, color, or combination of those things, you might consider registering a trademark with the United States Patent and Trademark Office (USPTO). A trademark identifies the source of a product or service and distinguishes one business from another. The most commonly trademarked asset is a business name.

You’ll need to conduct a trademark search to make sure the name or other identifying object is not already in use and pay an application fee, normally ranging between $250 and $350. You are encouraged to apply online, and your trademark will be good for 10 years before you’ll need to renew it.

Be Confident Your Side Business is Protected

As side hustles become more and more common, it’s likely they’ll garner additional attention from the IRS and other regulatory agencies. That means it will be increasingly important for you to make sure your side business complies with any regulations that apply, and you’ve covered all your bases in protecting it from any legal issues.

Regulations and laws change, and it’s your responsibility to keep up with those changes. If you have questions relating to any legal issues affecting your extra job, you should consult a legal or tax expert.