AI & Digital Side Hustles: How the IRS is Cracking Down in 2025

The rise of AI and digital side hustles has created new opportunities for entrepreneurs, but it has also caught the attention of the IRS. As more individuals generate income from AI-generated content, digital product sales, and online platforms, tax compliance is becoming a hot topic. Here’s what you need to know to stay ahead of IRS scrutiny in 2025.

1. The IRS is Targeting Digital Income More Aggressively

With the rise of online business models, the IRS is increasing efforts to track and tax income earned from:

• AI-generated content (ebooks, artwork, courses, etc.)

• Online coaching and consulting

• Subscriptions and memberships (OnlyFans, Patreon, etc.)

• Digital product sales (templates, software, prompts, etc.)

• AI-powered automation tools and reselling services

How This Affects You: If you're earning money from digital platforms, expect more scrutiny. Failing to report income could result in audits, penalties, and interest on unpaid taxes. Keeping thorough records and using accounting software can help ensure compliance and avoid unexpected tax bills.

2. The $600 1099-K Reporting Rule

One of the most controversial tax changes is the lowered reporting threshold for third-party payment apps like PayPal, Venmo, and Cash App. Originally set at $20,000 across 200 transactions, the new rule requires payment platforms to issue Form 1099-K to individuals who receive over $600 in total payments for goods and services. This means:

• Even small-time sellers and content creators may receive a 1099-K.

• The IRS will have a clearer view of digital income sources.

• Hobby sellers could unintentionally owe self-employment taxes.

How This Affects You: If you receive a 1099-K, you must report the income, even if it was a one-time sale or a casual side hustle. Failure to do so could trigger an IRS audit. Keeping track of deductible expenses can help offset taxable income.

3. Self-Employment Tax & Business Deductions

If you’re making money from a digital side hustle, you may be considered self-employed, which means you owe 15.3% in self-employment tax on top of income tax. However, strategic tax planning can help reduce your liability. Common deductions include:

• Home office expenses (if you work from home)

• Software subscriptions (AI tools, Canva, Adobe, etc.)

• Equipment costs (laptops, microphones, cameras)

• Marketing expenses (ads, social media management tools)

• Business coaching or training programs

How This Affects You: Understanding self-employment tax is crucial—many digital entrepreneurs underestimate their tax liability and get caught off guard at tax time. Maximizing deductions can significantly reduce the amount you owe.

4. AI-Generated Content & Intellectual Property Taxation

AI-powered businesses come with unique tax challenges, particularly when monetizing AI-generated content. Questions still being debated include:

• Are AI-generated products subject to royalty income taxation?

• Do AI-powered businesses qualify for the Qualified Business Income (QBI) Deduction?

• How should prompt engineering businesses report earnings?

How This Affects You: If you're earning passive income from AI-generated products, you may face complex tax rules. Proper classification of income can impact how much tax you owe, so working with a tax professional can help you optimize your tax position.

5. Crypto, NFTs & Digital Payments

If you’re accepting cryptocurrency, NFTs, or digital tokens as payment, you have additional reporting responsibilities. The IRS now requires:

• Reporting crypto sales and conversions as capital gains.

• Tracking NFT sales and determining whether they’re subject to collectibles tax rates (up to 28%).

• Full transparency with digital wallets and blockchain transactions.

How This Affects You: Crypto transactions are highly traceable, and failing to report them can result in audits or penalties. If you frequently trade or accept crypto payments, consider using tax software specifically designed for cryptocurrency tracking.

6. State & Sales Tax Compliance for Digital Entrepreneurs

Selling digital products? You may be subject to state sales tax, even if you don’t have a physical storefront. Many states require online sellers to collect sales tax on:

• Ebooks, courses, and templates

• Software and AI-generated tools

• Subscription-based digital services

How This Affects You: Each state has different sales tax laws, and failure to comply can result in back taxes, penalties, and interest. Understanding where you have nexus (a taxable presence) is crucial to staying compliant.

How to Stay IRS-Compliant and Keep More of Your Earnings

1. Track all digital income. Use accounting tools or consult a CPA to ensure accurate reporting.

2. Separate business and personal finances. A dedicated business account can simplify tax filing.

3. Leverage business deductions. Don’t miss out on write-offs that reduce your taxable income.

4. Plan for quarterly taxes. If you expect to owe over $1,000, make estimated payments to avoid penalties.

5. Stay informed. IRS rules on digital income are evolving, so work with a tax professional to stay compliant.

   
   

Final Thoughts

The digital economy is booming, and with it comes increased IRS scrutiny. Whether you’re an AI entrepreneur, content creator, or e-commerce seller, understanding your tax obligations is crucial. By staying proactive and leveraging smart tax strategies, you can stay compliant while maximizing your profits.

Need help navigating digital taxes? Dylan Razzagone, CPA, specializes in tax planning for digital entrepreneurs. Contact us today for expert guidance on tax savings and compliance!