You Started a Side Business in South Dakota. Here’s What Changes on Your Tax Return (and What Lang Tax Solutions Sees Most People Miss)

You launched a side business last year. Maybe you started freelancing, opened an Etsy shop, picked up contract work, or turned a skill into an LLC. Revenue came in. You felt good about it. Now tax season is approaching and you’re realizing that the return you’ve been filing for years, the straightforward W-2 with a standard deduction, no longer applies. Living in South Dakota means you don’t have a state income tax return to worry about, which is a genuine advantage. But it also creates a false sense of simplicity. Lang Tax Solutions works with first-year and early-stage business owners across the Sioux Falls area who assumed their taxes would stay easy and discovered otherwise. The federal return for someone with self-employment income is a fundamentally different document than a return with only W-2 wages, and the mistakes people make in year one can follow them for years.

Self-Employment Tax Is the First Surprise

When you work for an employer, you pay 7.65 percent of your wages in FICA taxes (Social Security and Medicare), and your employer pays the other 7.65 percent. You never see their half. It just happens.

When you’re self-employed, you pay both halves. That’s 15.3 percent on your net self-employment income, on top of your regular federal income tax. If your side business netted $30,000 in profit last year, you owe roughly $4,590 in self-employment tax before your income tax is even calculated. For someone who has only ever seen FICA as a modest line item on a pay stub, that number is a shock.

The partial offset is that you can deduct the employer-equivalent portion (half of the self-employment tax) from your adjusted gross income. It doesn’t reduce the self-employment tax itself, but it reduces your taxable income for income tax purposes. Most first-time filers don’t know this deduction exists because it’s not an itemized deduction and it doesn’t appear on Schedule C. It shows up on Schedule SE and flows to Schedule 1. If you’re doing your return yourself and you miss it, you’re overpaying.

Quarterly Estimated Taxes: The Penalty Nobody Warns You About

Your employer withholds income tax from every paycheck throughout the year. When you have self-employment income, nobody withholds anything. The IRS still expects to receive tax payments throughout the year, not in one lump sum in April. The mechanism for this is quarterly estimated tax payments, due in April, June, September, and January.

If you earned self-employment income in the current tax year and didn’t make quarterly payments, you may owe an underpayment penalty when you file. The penalty is essentially interest on the tax you should have been paying throughout the year. It’s not enormous for most first-year side businesses, but it’s an avoidable cost that catches people off guard.

The safe harbor rule provides some protection: if your total tax payments (through W-2 withholding and any estimated payments you did make) equal at least 100 percent of last year’s total tax liability, or 110 percent if your AGI was over $150,000, you won’t owe the underpayment penalty regardless of how much your current-year liability increased. For someone who started a side business mid-year and still has a full-time W-2 job, increasing the withholding on the W-2 can sometimes cover the additional tax and eliminate the need for separate quarterly payments. It’s not the textbook approach, but it works mechanically and it’s simpler for people who find quarterly payments easy to forget.

The QBI Deduction Most Side Business Owners Don’t Claim

The Qualified Business Income deduction under Section 199A allows eligible self-employed individuals and pass-through business owners to deduct up to 20 percent of their qualified business income from their taxable income. For a side business that netted $30,000, that’s a potential $6,000 deduction, which at a 22 percent marginal rate saves about $1,320 in federal tax.

The QBI deduction is available to sole proprietors, single-member LLCs, partnerships, and S-corps. It phases out at higher income levels for certain service businesses (specified service trades or businesses, in IRS terminology), but most side business owners in Sioux Falls are well below those thresholds.

The reason people miss it is that tax software sometimes handles it correctly and sometimes doesn’t, depending on how the business income is entered. If you’re filing with TurboTax or a similar program and you don’t classify your business income correctly, the software may not apply the deduction. A professional preparer who works with self-employment returns catches this routinely.

Deductions You’re Entitled to but Probably Aren’t Tracking

Self-employment opens up a category of deductions that don’t exist for W-2 employees. The challenge is that they require documentation, and most first-year business owners don’t set up tracking systems until it’s too late to reconstruct a full year of expenses.

Home office deductions are available if you use a dedicated space in your home exclusively and regularly for business. The simplified method allows a deduction of $5 per square foot up to 300 square feet ($1,500 maximum). The actual expense method can produce a larger deduction but requires tracking your mortgage or rent, utilities, insurance, and maintenance as a percentage of total home area used for business.

Vehicle mileage is deductible for business-related driving. The IRS standard mileage rate for 2025 is 70 cents per mile. If you drove 5,000 miles for business purposes last year, that’s a $3,500 deduction. But you need a contemporaneous log. Reconstructing mileage from memory at tax time doesn’t meet IRS requirements and won’t survive an audit. Apps like MileIQ or a simple spreadsheet work, but you have to start using them.

Business supplies, software subscriptions, professional development, marketing costs, and business insurance premiums are all deductible. So are fees paid to a CPA or tax preparer for your business return. The common pattern Lang Tax Solutions sees with new business owners is that they incurred these expenses throughout the year but didn’t separate them from personal spending. When they arrive at tax time, they can’t identify which purchases were business-related and which were personal. A bookkeeping system, even a simple one, that separates business and personal transactions from day one prevents this.

Hobby vs. Business: A Distinction the IRS Cares About

If your side business didn’t turn a profit in its first year, or if the profit was small relative to the effort involved, the IRS may classify your activity as a hobby rather than a business. Hobby income is still taxable, but hobby expenses are not deductible. That means you’d pay tax on the revenue without being able to offset it with your costs.

The IRS uses several factors to distinguish a business from a hobby: whether you operate in a businesslike manner (separate bank account, records, a business plan), whether you depend on the income, whether your losses are from startup circumstances or from ongoing operations, and whether you’ve made a profit in three of the last five years. You don’t need to satisfy all of these, but you need to show that you’re operating with a genuine intent to make money.

For first-year businesses that operated at a loss, keeping organized records and demonstrating a profit motive protects your ability to deduct expenses. If the IRS reclassifies your business as a hobby, you lose those deductions retroactively and owe additional tax plus potential penalties.

Getting Your First Business Return Right with Lang Tax Solutions

The first year of a side business sets the pattern for every year that follows. The deductions you establish, the tracking systems you build, the quarterly payment schedule you set up, and the way your business income is reported on your return all carry forward. Getting year one right means year two is easier, and year three is routine.

Lang Tax Solutions works with individuals and business owners in Sioux Falls and remotely to handle exactly this transition from simple W-2 filing to self-employment returns. Jeff and the team will identify the deductions you’re entitled to, set up the quarterly payment schedule that keeps you penalty-free, and make sure your return is structured to take advantage of the QBI deduction and every other provision that applies to your situation. If your bookkeeping needs work, they handle that too.