Tax FAQ: Do you have to pay taxes on a side hustle? What if you miss the deadline? And more

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You can probably palpably remember that first paycheck you got — and the gut punch that followed when you realized how much was taken out in taxes. That blow can feel even worse if you do freelance or gig work and your employer doesn't take taxes out.  

I'll never forget the first time that happened to me and I learned what a 1099 form was. (We'll explain that later.) I was in my 20s and had agreed to a freelance assignment for two weeks at the CeBIT trade show in Hanover, Germany. I negotiated what I thought was a very nice pay rate — a couple thousand dollars — and I was feeling like a total baller for rolling that high and traveling internationally for work.

I thought: This is what it feels like to be an adult and make good money.

Months later, I realized I would have to pay about 50% of that back for taxes. Even though I had already spent it. That's when I found out what it really feels like to be an adult. If learning how much of my paycheck went to taxes was a gut punch, this was a full-on, top-of-the-ropes body slam.

The moral of this story, in three parts:

1. I am not nearly as cool as 25-year-old me thought I was
2. Know your tax rate
3. Don't spend your whole paycheck

"Generally, most people understand they owe taxes on the income they earn, but often they don't understand how they are taxed and the many different ways they are taxed," says Angie O'Leary, head of wealth planning and insured solutions, RBC Wealth Management.

"This is often revealed for the first time when they earn income from being an official employee or a 'W2 wage earner' where taxes are automatically withheld for the individual. This may get magnified with their first full-time career paycheck where they see their take-home pay is materially lower than expected based on their employment offer."

That was me.

When I first got out of college, I lived in Hoboken, New Jersey, and was working in New York City. Once again, I felt like a total baller because I had figured out a way to get a bigger apartment for less money than it would cost me in Manhattan — but I could still work and go out.

Well, here was the other big surprise for me when it came to taxes: For that genius move, I not only had to file taxes in New Jersey, where I lived, but also in New York state, because that's where my company was based. (On top of that, NYC residents owe a city income tax, which may also apply to some nonresidents.)

For the record, you don't have to pay taxes in two states in that case — note that I said I had to "file" taxes in both places — because you'd generally get a credit from one of the states. And city taxes are generally only around 2% to 4%.

Still, it can add up. And the fact that you have to file in four places instead of the standard two — federal and state — makes filing your taxes a little more complicated. A little more expensive, too, if you are using an accountant.

For the record, I loved living in Hoboken and would do it all over again in a heartbeat. But maybe I would do my homework first on exactly how much it would cost to live there and what taxes I'd have to pay, and plan accordingly.

What do most people get wrong about their income taxes? 

"Primarily for early career folks, they don't understand how many different types of taxes automatically come out of their payroll check and which ones are important when it comes to calculating both their federal and state taxes that they owe or likely don't owe," O'Leary says. "For example, it is important to understand how you are paying taxes into your future Social Security and Medicare benefits as well as any additional state or local taxes that may be withheld."          

Here are a few other things you need to know about your taxes:

1. What is your classification? If you are a full-time employee with a company that takes out taxes, you will fill out a W-4 form when you start and get a W-2 back at the beginning of every year to file your taxes for the previous year. If you are paid as a freelance, contract or gig worker and your employer doesn't take taxes out, you fill out a W-9 form when you start and get a 1099 form at the beginning of every year. (We'll talk about side hustles later.)
   
2. How much is your employer withholding from each paycheck for taxes? If you are a full-time employee of a company that withholds taxes, you choose how much the company withholds from each paycheck for taxes when you fill out that W-4 form.
   
   "For most, this will be a simple option based on your tax filing status and your expectations for deductions beyond the standard deduction. However, there are some circumstances that may warrant minimizing the taxes that are withheld or requesting additional taxes be withheld," O'Leary says. "How much you really owe in taxes will be determined when you file your taxes and will vary based on your total income and progressive tax bracket, any tax credits and tax deductions."
   
   If you're just getting started in your career, chances are you will likely get a full or partial refund of taxes that have been withheld, O'Leary explains. "As your earned income grows with your career, your taxes will progressively grow. Keep in mind, if you withhold too little and have a material tax bill at the end of the year, you could face a penalty."
   
3. What is your federal income tax rate? If you're not sure of your tax rate, you can check out the tax rates here for 2022 — and 2023, to get ahead for next year.
   
4. Do you have to pay state or city taxes? Not all states have income taxes, and even among those that do, it varies — some have brackets and others are a flat rate. Check your state tax rate. Some cities also have income taxes — as I learned the hard way with New York City — so make sure you know if your city does, what that rate is and what forms you have to file.
   
   In case you're wondering, the states that don't have income taxes are: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming. There is no income tax in New Hampshire or Washington, either, but both states tax investment earnings. For comparison, here's a look at state tax rates and brackets from the Tax Foundation.
   
5. When is the tax deadline? It's important to know the tax deadline — this year it's Tuesday, April 18.

If you need more time to file your taxes, you can file for an extension, which would give you until Oct. 16 to file. You can get help filing a federal extension for free via IRS Free File, regardless of your income.

You may need to file your state tax extension separately. But you still must pay taxes by the original deadline to avoid penalties and interest.

The late-filing penalty is 5% of your unpaid taxes per month, up to 25%, plus interest. By comparison, the late payment penalty is 0.5% of your unpaid balance per month, up to 25%.

If you miss the deadline entirely and enough time has passed, the IRS can seize a portion of your wages until you pay what you owe. And, if you were due a refund, you could risk losing that money.  

If you made a net profit of $400 or more from your side hustle, you have to pay taxes on it, according to the IRS.

"Any earned income is subject to taxes and when you work for yourself or are a 1099 worker, there are no taxes withheld so you will be responsible for saving for any taxes due," O'Leary says. "You are also responsible for paying Social Security and Medicare taxes, at a higher rate, as you are paying the employer portion of the tax as well."

You report self-employment income on Schedule C, which flows to Form 1040.

If you make more than $20,000 or 200 transactions using a third-party payment app like Venmo or PayPal, you may get a Form 1099-K from them. A new rule which goes into effect next year means a transaction of $600 or more could trigger the form. But for 2022, you still must report business income on your taxes, even if you don't receive Form 1099-K.

The U.S. has a pay-as-you-go system, so you'll need to pay taxes from your side hustle on a quarterly basis. The first quarterly tax deadline for 2023 is April 18.

The IRS has a great guide for all you need to know about filing taxes for your gig work, including a calculator to estimate what you will owe in taxes.

It's a good idea to set aside 25% to 30% of your income for taxes. A lot of financial advisors recommend opening a separate savings account for this — that way the money is there when you need it and it's earning interest in the meantime. Right now, high-yield savings accounts are earning 3% to 5%, according to Bankrate. That can really add up if you keep that money in there for the next year.

If you are a freelancer or gig economy worker, one way to lower your tax bill is to open a solo 401(k) retirement plan and make contributions. You can take a deduction on those contributions. And, next year, thanks to a change to the tax law, you'll be able to deduct even more for contributions after year-end.

If you have a full-time job with an employer in addition to your side hustle, you might consider having your employer withhold extra taxes, O'Leary says.

Many of us worked from home during the pandemic — and some of us still are, at least a few days a week.

If, like me, your back and neck pain is making you feel like you're 100, you have probably invested in some home-office equipment to make it more comfortable.

Can you deduct those expenses from your taxes?

Kate Dore reports that, for most of us working full-time and getting a W-2 from our employer, we probably can't deduct our home office expenses. But, if you are a contractor or self-employed filing a 1099 form, it's possible.

One of the key rules is that you must use your home office exclusively for work.

Read more about who qualifies for the home office deduction this year, according to tax pros.

Let's face it — taxes are hard and annoying. I mean, if you gave me the option of having to do my taxes or getting a root canal, I'd have to seriously think about that. And I hate going to the dentist.

But everyone has to file their taxes, and after all, this is our money. So, even if we are getting help from an accountant or a tax software program, we need to know this stuff.

How much do you really know about taxes? For example:

• Let's say you need a tax extension. Do you know how long that buys you?
• Can you deduct student loan interest?
• Do you know if there is a penalty for not paying your taxes on time?
• Do you know if you can deduct your home office expenses?

Take our tax quiz to find out. Don't worry if you don't know all the answers — or even the answer to the first question. The answers are provided at the end and, guaranteed, you'll come away with more tax knowledge than when you started.

Have more questions about taxes? Check out CNBC's Smart Tax Planning Guide.

When in doubt, consult a tax professional. The extra money you spend could wind up saving you even more — in money as well as frustration.

— With reporting by Kate Dore, Sharon Epperson, Macklin Fishman and Megan DeMatteo.

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• Don't believe these 5 tax myths

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