Graphics design on the side

Hi there! I'm speaking from personal experience here, not as an accountant or lawyer. This is also applicable to the US only, although it's likely analogous in other countries.

tl;dr version: when going legit, be prepared for a lot of paperwork and to kiss a lot of your money goodbye. If you don't go legit, though, you could get in a lot of hot water. People do go to jail for tax evasion.

The first thing you will need to do is register as a business with whichever local governments care about such things. Given what you do, you would either file as a sole proprietor or an LLC. (There are advantages for being registered as an LLC if you get sued, because it provides partial protection for your personal assets.) For example, I live in a city in Washington state, and both the city and the state require you to register as a business with them. They both charge annual business license fees. Their fees are more expensive for LLCs than for sole proprietorships. Once you have done that, you need to research these local governments to see if they charge taxes for your business for the amount you are making. My city, for example, doesn't charge anything beyond the business license, and my state doesn't charge unless you clear a certain amount of revenue. If you're below a certain (much smaller) level of revenue, they don't even require you to file.

The Feds don't require you to register as a business, but they do require you to file income tax forms no matter the amount you make. As a sole proprietor or an LLC (the Feds don't distinguish between the two if you're the only one in your LLC), you file on your personal income taxes, and you'll need to file a full 1040, not the EZ. You fill out Schedule C or C-EZ depending on your business, revenue, and expenses. You also have to file the SE to determine your self-employment tax, which is the part of payroll taxes (social security, medicaire, etc.) that your employer would ordinarily pay. They do offer 50% of SE tax as a deduction, though.

Of course this all gets SOOO much more complicated if you're in a partnership or if you employ anyone, as a contractor or actual employee.

Since you have a day job, this can get quite expensive. You end up paying regular income tax at your highest tax rate, plus the self-employment tax. This can easily reach over 40 cents on the dollar. Whee!

Unless you're very familiar with filing your own taxes, you may want to take all this to a tax preparation firm like H&R Block, or, if you have a lot of business expenses and want to be sure whether you can claim them, a full-on accountant firm. Both of those also cost money. If you have some familiarity with filing your own taxes (I did mine with a pencil and calculator, even while running a business, until about three years ago), I would still recommend TurboTax. It's a good, and relatively inexpensive, way to go. Once you've done that for a couple years, you may feel comfortable going back to the OG way of doing things.

Best of luck to you!