Author Topic: Any way to turn dividends into self-employment income?  (Read 1473 times)

msilenus

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Any way to turn dividends into self-employment income?
« on: May 15, 2018, 09:41:26 PM »
Usually this is like asking how to shoot yourself in the foot, but it may not be in my case.  Scenario:
    * First year of FIRE after working a partial year.
    * MAGI (after earned income + IRA contributions + 401k + HSA) is on track to be significantly under 4x federal poverty level.  (The Obamacare "subsidy cliff.")    HOWEVER:
    * Unless we do something clever, dividends will likely push us over, sacrificing about $750/mo in premium subsidies. 

If there's some bit of alchemy I can perform to turn those dividends into self-employment income, then I'll be able to deduct them out of my MAGI on what is now line 29 on form 1040, keeping us decidedly under the limit.  Since ~$5,000 in subsidies are at risk, being taxed suboptimally can prove worthwhile.

I know personal taxes pretty well, but business/self-employment stuff is pretty alien to me.  Is there any way to do this thing?  If so, what's the cheapest way to do it?

bacchi

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Re: Any way to turn dividends into self-employment income?
« Reply #1 on: May 16, 2018, 12:03:56 PM »
No, not without a complicated scheme possibly involving a family business or your own hedge fund.

Donate the dividends. Sell the high yield stock to avoid this issue in the future.

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #2 on: May 16, 2018, 12:26:41 PM »
Thanks.  Donating doesn't work though because those deductions are itemized and I need something that hits AGI directly.  IRA/401k/HSA are already tapped out for that purpose, so I'm trying to get creative.  I'm not against complicated schemes like creating my own hedge fund.  I'll look into what's involved with that.

I don't really have much in high-yield stocks.  Index mutual funds are 80%+ of this story.  I'm just really close to the cutoff.

I just realized that another possibility is making an absurdly risky options play with a premium of exactly $3,000.  Most likely I lose the money and can put a $3k deduction against my AGI.  If that puts me over the line, then I come out $2,000 ahead after taxes.  (Gamblers call this "free-rolling.")

If it pans out, OTOH, then:
a) If I made $X < $5k after taxes, then I can buy another option with a premium of $3k + X.
b) If I made > $5k after taxes, then bully for me.  I just paid for my premiums w/o help from the government.  (Or I could just let it ride again per 'a', b/c I can deduct losses against this gain.)

Hedge fund would still be better if I can create one for <~$2k.

protostache

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Re: Any way to turn dividends into self-employment income?
« Reply #3 on: May 16, 2018, 02:04:49 PM »
  • Form an LLC and elect C corp taxation
  • Contribute the dividend-paying equities as a capital contribution
  • Pay yourself a salary with the dividends

Presto change-o your dividends are now earned income!

Additional costs with this scheme:

  • Your dividends that were taxed at 0% are now taxed at ordinary income rates
  • 15.3% additional self employment (Social Security and FICA) tax
  • FUTA and possibly state unemployment tax and possibly mandated state unemployment insurance
  • Tax preparation for your shiny C corp probably runs around $1,000

How much in dividends are we actually talking about here? Is all of this rigamarole actually worth it for the Obamacare subsidies?

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #4 on: May 16, 2018, 02:40:29 PM »
  • Form an LLC and elect C corp taxation
  • Contribute the dividend-paying equities as a capital contribution
  • Pay yourself a salary with the dividends

Presto change-o your dividends are now earned income!

Additional costs with this scheme:

  • Your dividends that were taxed at 0% are now taxed at ordinary income rates
  • 15.3% additional self employment (Social Security and FICA) tax
  • FUTA and possibly state unemployment tax and possibly mandated state unemployment insurance
  • Tax preparation for your shiny C corp probably runs around $1,000

How much in dividends are we actually talking about here? Is all of this rigamarole actually worth it for the Obamacare subsidies?

Thanks!  That's exactly what I was looking for.  It doesn't work exactly as I thought, because I'm not self-employed if I'm the owner of a C-Corp, so I don't get the self-employment exclusion.  However, as the sole employee, I think the C-Corp can pay my insurance premiums out of the dividends (revenue), which should keep them from appearing on my 1040 and ultimately amount to the same thing.  I think that also avoids payroll and corporate taxes on that amount.

If I did this optimally, I don't think I would owe any tax on either the business-side or personal-side.  I would only contribute enough stock for my health insurance premiums to be completely paid by dividends --and no more. 

If I DIY everything, my fixed costs are $125 from the state to set up the C-Corp, $169 from TurboTax for the corporations version, $15 to dissolve the C-Corp in 2019, and the $800 minimum state tax per year filing with the corp in existence.  (This is California.)  Total cost is just under $2,000 if I have to pay that tax in both years, or just over $1000 if I can dissolve the corp in Dec. 2018 and still get all the benefits.  (Not immediately clear to me.)

secondcor521

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Re: Any way to turn dividends into self-employment income?
« Reply #5 on: May 16, 2018, 04:40:50 PM »
It might be cheaper to try to obtain some adjustments to income.  Some ideas:

1.  Realize a capital loss greater than any capital gains.  Write off $3K against ordinary income on 1040 line 13.

2.  Start a business, do poorly or have lots of expenses.  Create a business loss of $3K on 1040 line 12.

3.  I think casualty losses might work.  Burn down part of your house?  Probably fraud, so I don't recommend it seriously.
 Line 14.

4.  Since you use "we" in your OP, you could divorce your spouse on paper and then pay them alimony.  Hard to do that and still pay their ACA premiums, but...line 31a.


seattlecyclone

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Re: Any way to turn dividends into self-employment income?
« Reply #6 on: May 16, 2018, 05:06:25 PM »
Do you have any shares in your taxable accounts you can sell for a loss, or at least for minimal gain? The market is a bit down from the all-time high earlier this year, so if you bought anything in 2018 then you could sell those, reduce your dividend exposure for the rest of the year, and realize minimal capital gains to offset that. Reinvest in some stocks that pay no dividends.

If you have charitable ambitions during FIRE, front-load that a bit by funding a DAF account. This will also reduce your dividend exposure going forward.

You can also play the penny stock or option game very badly, losing up to $3,000.

I wouldn't personally feel right about the C corp idea unless I planned to start an actual business that did more than pay me a salary out of invested capital. Seems sleazy to me.

SeattleCPA

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Re: Any way to turn dividends into self-employment income?
« Reply #7 on: May 17, 2018, 02:23:53 PM »
I think this idea falls into the "sham transaction" category. If an IRS agent agreed, the service would rearrange the transaction so it made sense.

jacoavluha

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Re: Any way to turn dividends into self-employment income?
« Reply #8 on: May 17, 2018, 09:19:12 PM »
Usually this is like asking how to shoot yourself in the foot, but it may not be in my case.  Scenario:
    * First year of FIRE after working a partial year.
    * MAGI (after earned income + IRA contributions + 401k + HSA) is on track to be significantly under 4x federal poverty level.  (The Obamacare "subsidy cliff.")    HOWEVER:
    * Unless we do something clever, dividends will likely push us over, sacrificing about $750/mo in premium subsidies. 

If there's some bit of alchemy I can perform to turn those dividends into self-employment income, then I'll be able to deduct them out of my MAGI on what is now line 29 on form 1040, keeping us decidedly under the limit.  Since ~$5,000 in subsidies are at risk, being taxed suboptimally can prove worthwhile.

I know personal taxes pretty well, but business/self-employment stuff is pretty alien to me.  Is there any way to do this thing?  If so, what's the cheapest way to do it?

Where is your earned income from? You mention self employment. Do you have self employment income already?

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #9 on: May 18, 2018, 11:25:27 AM »
It might be cheaper to try to obtain some adjustments to income.  Some ideas:

1.  Realize a capital loss greater than any capital gains.  Write off $3K against ordinary income on 1040 line 13.

2.  Start a business, do poorly or have lots of expenses.  Create a business loss of $3K on 1040 line 12.

3.  I think casualty losses might work.  Burn down part of your house?  Probably fraud, so I don't recommend it seriously.
 Line 14.

4.  Since you use "we" in your OP, you could divorce your spouse on paper and then pay them alimony.  Hard to do that and still pay their ACA premiums, but...line 31a.

Any thoughts on how to achieve 2 without large real losses?  My wife started teaching online classes this year.  Basically tutoring.  Sole proprietorship so far.  It's a low-overhead gig, though.  I've been digging into how we could show a business loss on 1040 with that, but it looks like the home office deduction, business-side insurance deduction, and self-employment insurance deduction all have earned income limitations.   My OP already assumes I'll be able to deduct all that income against expenses like these, so that doesn't move the needle without finding a way to take things negative.

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #10 on: May 18, 2018, 11:52:40 AM »
I think this idea falls into the "sham transaction" category. If an IRS agent agreed, the service would rearrange the transaction so it made sense.

Thanks.  I'm reading into this, and I don't think it's a sure bet that they would.  It seems like typically when the IRS uses this rule, there's some sort of pricing controversy associated with a specific transaction that is a sham, usually around a non-arms-length transaction. [1]  This doesn't look like that because all the transfers would be of market-traded securities with no pricing ambiguity.  It does result in a lower overall tax burden, but if choosing business structure to minimize total tax burden could be disallowed per se, then a lot of tax planning activities wouldn't make sense, right?

I realize I'm not an expert in this area, so I'm taking this counter-argument of mine with a grain of salt.  What am I missing, though?

[1] https://klasing-associates.com/question/sham-transaction-doctrine/

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #11 on: May 18, 2018, 11:55:14 AM »
Where is your earned income from? You mention self employment. Do you have self employment income already?

Almost all of the income is from jobs.  I quit mine this year after earning some of it.  My wife is working quarter-time for the rest.  She has some self-employment income as well starting this year, but I'm already assuming we'll be able to deduct that all away using the home office deduction.  The income from that activity is pretty low, and we're in one of those inflated real estate markets.

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #12 on: May 18, 2018, 12:11:51 PM »
Do you have any shares in your taxable accounts you can sell for a loss, or at least for minimal gain? The market is a bit down from the all-time high earlier this year, so if you bought anything in 2018 then you could sell those, reduce your dividend exposure for the rest of the year, and realize minimal capital gains to offset that. Reinvest in some stocks that pay no dividends.

If you have charitable ambitions during FIRE, front-load that a bit by funding a DAF account. This will also reduce your dividend exposure going forward.

You can also play the penny stock or option game very badly, losing up to $3,000.

I wouldn't personally feel right about the C corp idea unless I planned to start an actual business that did more than pay me a salary out of invested capital. Seems sleazy to me.

All our taxable assets are appreciated right now. 

More DAF contributions would be below-the-line deductions. They'd reduce dividend exposure, but that's a second-order effect.  Besides: we planned things out so that our DAF reached what we expect to be its peak size in the last two years (when our income was highest.)  This year we're working partial years and our marginal tax rate is going to be pretty low.

In response to the sleazy thing, I'm reminded of Tim Cook's recent Congressional testimony: "Apple pays every tax dollar we owe."  Don't hate the player. :D
« Last Edit: May 18, 2018, 12:13:54 PM by msilenus »

secondcor521

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Re: Any way to turn dividends into self-employment income?
« Reply #13 on: May 18, 2018, 12:17:21 PM »
It might be cheaper to try to obtain some adjustments to income.  Some ideas:

1.  Realize a capital loss greater than any capital gains.  Write off $3K against ordinary income on 1040 line 13.

2.  Start a business, do poorly or have lots of expenses.  Create a business loss of $3K on 1040 line 12.

3.  I think casualty losses might work.  Burn down part of your house?  Probably fraud, so I don't recommend it seriously.
 Line 14.

4.  Since you use "we" in your OP, you could divorce your spouse on paper and then pay them alimony.  Hard to do that and still pay their ACA premiums, but...line 31a.

Any thoughts on how to achieve 2 without large real losses?  My wife started teaching online classes this year.  Basically tutoring.  Sole proprietorship so far.  It's a low-overhead gig, though.  I've been digging into how we could show a business loss on 1040 with that, but it looks like the home office deduction, business-side insurance deduction, and self-employment insurance deduction all have earned income limitations.   My OP already assumes I'll be able to deduct all that income against expenses like these, so that doesn't move the needle without finding a way to take things negative.

Well, first, they have to be "real" losses in order to deduct them.  Don't deduct fake losses, that's against the law.

My general suggestion would be to purchase things that are necessary to the business that might help you grow it in the future.  So for example, maybe your wife needs to pay for a business license with your local secretary of state's office.  Maybe she needs a new computer for her business that can handle online streaming better.  Maybe she needs textbooks or  marketing materials or needs some tax consulting since your taxes may be more complicated.  Maybe you get her a business credit card that has an annual fee.  Maybe she goes to a trade show or conference to try to drum up business or develop her skills in the areas in which she is tutoring.  Those sorts of things.  In general, look at a Schedule C and see what sorts of expenses can be deducted against income.

One final comment:  I read one time a long time ago when my (now ex-)wife was doing a home-based business that you can't deduct business expenses during startup; you can only deduct them once the business is up and running.  I don't know that I ever found an authoritative cite on IRS.gov about that, but it was something that sticks in my memory and I wouldn't want you to be unaware of that potential limitation.  Consult your tax professional for real advice.

Rocketman

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Re: Any way to turn dividends into self-employment income?
« Reply #14 on: May 18, 2018, 12:43:17 PM »
Look hard at the home office expenses - make sure you really qualify for all of it. The most common item of disallowed is you use that space ONLY for business and it is necessary to meet with clients there.

A better place is look for income reductions is under a solo 401k for her business. I think you can deduct something like 92% of the income. (As long as the income limits are not reached).

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #15 on: May 18, 2018, 02:22:55 PM »
Look hard at the home office expenses - make sure you really qualify for all of it. The most common item of disallowed is you use that space ONLY for business and it is necessary to meet with clients there.

A better place is look for income reductions is under a solo 401k for her business. I think you can deduct something like 92% of the income. (As long as the income limits are not reached).

Thanks, but I believe we pass those tests.  If we can exclude the income w/o sequestering it in a retirement account that's preferable because we can spend the marginal dollars for immediate expenses.

MidWestLove

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Re: Any way to turn dividends into self-employment income?
« Reply #16 on: May 19, 2018, 11:22:24 AM »
In response to the sleazy thing, I'm reminded of Tim Cook's recent Congressional testimony: "Apple pays every tax dollar we owe."  Don't hate the player. :D

And?
does it make any less sleazy because someone else somewhere else did something else?  you are asking about things that are threading the line on outright fraud -  the answer (and you know it very well), is no , you should not cheat this way.

pay the premiums and move on... or work less/tutor less (take your wife on wonderful 6 month cruise around the world, she would love it), or many other things.  you are FIRE, enjoy it.


I do not know how much you hate your carma (and your own morals) to discard it over few dollars... what goes around , comes back..
« Last Edit: May 19, 2018, 11:24:46 AM by MidWestLove »

msilenus

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Re: Any way to turn dividends into self-employment income?
« Reply #17 on: May 20, 2018, 05:46:49 PM »
And?
does it make any less sleazy because someone else somewhere else did something else?  you are asking about things that are threading the line on outright fraud -  the answer (and you know it very well), is no , you should not cheat this way.

pay the premiums and move on... or work less/tutor less (take your wife on wonderful 6 month cruise around the world, she would love it), or many other things.  you are FIRE, enjoy it.


I do not know how much you hate your carma (and your own morals) to discard it over few dollars... what goes around , comes back..

I'm aggressive in how I do my taxes, it's true.  My last few seasons have involved hundred+ pages of returns even without any business income.  I file returns for each of my kids, because it allows us to eke out a (fairly small) tax advantage.  But I'm also very conservative: I declare and pay taxes on bank interest < $10 which goes unreported by the bank.  I pay ordinary income on ESPP share dispositions more than two years old, which most participants don't even know you're supposed to do.  I've never reported a charitable contribution I didn't make, even when that was very easy to get away with for low dollar amounts.  I research my tax strategies thoroughly before I use them to make sure I'm staying on the right side of the law, even though the IRS is underfunded and probably won't catch me if I make an error.

Which is to say that there's a system, and I optimize for it --hard,-- but I also respect its boundaries.  That's tax avoidance, not evasion, and morality has nothing to it.  It's not sleazy at all.  Everyone seriously involved in the formulation and implementation of the tax code understands that people will seek advantage within it.  This is a thread about trying to find a boundary, not crossing one.  Sleazy would be not caring where the boundaries are.

Sometimes it does get silly.  When the incentives in the system take us to silly places, it's more useful to think about changing the system than to look down on the silliness.  In this case: a phase-out that goes down to zero would patch the system nicely.
« Last Edit: May 20, 2018, 05:49:43 PM by msilenus »

tralfamadorian

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Re: Any way to turn dividends into self-employment income?
« Reply #18 on: May 20, 2018, 05:55:43 PM »
Anyone mention real estate yet? A new investment property can easily pull in lots of (very legal) paper losses.

SeattleCPA

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Re: Any way to turn dividends into self-employment income?
« Reply #19 on: May 21, 2018, 06:56:32 AM »
Anyone mention real estate yet? A new investment property can easily pull in lots of (very legal) paper losses.

+1

Real estate in past worked like a super-charged retirement account--the one catch being, you have to also contribute "sweat equity"...

BTW, I am not a hard core real estate investor. I saved for retirement using index funds inside tax-deferred accounts. Just mentioning that for context...
« Last Edit: May 21, 2018, 07:45:53 AM by SeattleCPA »

MustacheAnxiety

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Re: Any way to turn dividends into self-employment income?
« Reply #20 on: May 25, 2018, 05:11:11 PM »
Do you have any shares in your taxable accounts you can sell for a loss, or at least for minimal gain? The market is a bit down from the all-time high earlier this year, so if you bought anything in 2018 then you could sell those, reduce your dividend exposure for the rest of the year, and realize minimal capital gains to offset that. Reinvest in some stocks that pay no dividends.

All our taxable assets are appreciated right now. 


Do you have cash on hand that you want to invest?  Markets are so volatile right now that you have a reasonable chance of having a loss if you invest in a new low fee index fund now.  Kind of strange to hope for a loss, but if you have money on the sidelines put it in a new fund or new account so you can harvest the losses if there are losses for the remainder of the year.  Hopefully the markets don't continue to decline, but if they do you get something out of it.

EDIT: I have always just dealt with whatever Capital gains/losses were assigned by default by Fidelity.  But based on another post you can specifically identify shares that you want to sell.  So even if each fund is appreciated, you may be able to take a loss on shares purchased around January 26.  If I were in your shoes I would definitely investigate this kind of sale further with my broker.
« Last Edit: May 25, 2018, 05:18:44 PM by MustacheAnxiety »