Author Topic: A complex question: how best to reduce tax burden on a lucrative freelance job?  (Read 4671 times)

maryofdoom

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Hello friends,

Ready for a tricky question today?

I recently got hooked up with a sweet freelance gig, thanks to my sister's postdoc advisor, who is writing a book and needs some copyediting help. He is paying me $75/hour and there are at least 40 hours of work in this project. (Plus the possibility of more in the future if I do a good job, which is awesome.)

Most of my prior freelance work has either been for my dad, who pays me by personal check, or in annual amounts that add up to no more than $600. This job is clearly going to pay more than that.

I filled out paperwork for the author to allow him to pay me, including a contractor agreement and a W-9. Obviously this income will be reported to the IRS and I'll need to pay taxes on it for 2013. It's not a huge deal - but I'd like to reduce the tax hit as much as I can.

I have both a Roth IRA for my husband (that's been fully funded for 2013, thanks to cashing in a bad, old life insurance policy) and a traditional IRA for myself, to which I have contributed $2,640 year-to-date.

We also adjust our withholding so that we receive little to no refund - last year, we owed the state of PA because I cashed in a savings bond, but the federal government owed us only $11.

Would it reduce my tax burden if I were to contribute most of this freelance income to my traditional IRA, up to the annual limit? If the job is 40 hours at $75/hour, I would end up with $3,000, and could contribute $2,360 more to my IRA.

I told the husband we should ask our accountant - and we probably will - but I'm also asking all of you.

If you need more information, like information about our incomes or anything, just let me know.

SunshineGirl

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That would probably work about right. You'll need to pay both parts of FICA as an independent contractor, and then the rest could go to your traditional IRA. For larger amounts, you could open a Solo 401K.

Carrie

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Will you have any expenses you can write off?

Reepekg

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If you haven't maxed out your traditional IRA yet, do that first with the money.

If you checked individual/sole proprietor on your W-9, I've found the best way to reduce tax burden from freelance work is a SEP IRA (you can reduce earned income by ~20% up to $50,000 but read the rules). You can contribute to a SEP and traditional in the same year.

Other things to keep in mind: look at paying quarterly estimated taxes and filling out schedule C for this new freelance business

FinancialIndependenceTime

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It looks like her expenses will be minimal at best. Traditional IRA alone would give max deduction on the extra $3000 this year.

aj_yooper

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Contrarian thought:

The IRA only defers the tax until the time you retire; if you retire in the same bracket as you are in now, the net investment results are the same.  If the extra job money puts you in a higher current tax bracket, then the IRA transports the money back to your retirement bracket, which is a net gain.  You could take the hit and just put it in your Roth where it can grow and distributed without any further tax. 

feelingroovy

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I would say definitely talk with your accountant.

That said, I'm self-employed and have been looking into this a bit. (I am talking with my accountant this week. :) ).

This is how I understand it.

Putting the money into an IRA will definitely lower your overall tax burden because it lowers your adjusted gross income and can negate much of that extra income. But you'll still have to pay self-employment tax (both sides of social security) on the $3000, which appears on schedule C.

Any legitimate business expenses would reduce the amount on schedule C and therefore reduce the amount you spend on self employment income: mileage for meeting with the client, office supplies, postage, etc.

You do still need to show some profit though, or it's a red flag to the IRS.  They also want to see that your business income increases over the years, or they'll decide that your business is really a hobby, and you can't deduct business expenses.

And my understanding (which is still a bit fuzzy, hence my need for a talk with my accountant) is that if you do go beyond the personal IRA limit, a SIMPLE IRA allows you to contribute more than a SEP at small business incomes.  It's not limited to that 20%--you could put it the entire profit.

Milehimama

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I am a freelance writer and consultant, and don't overlook business deductions and mileage.  If you go to meet with the professor using a car- mileage. 

Set an area in your home for your work, and figure the square footage.  Then figure what percent of your home is used for business - say, it's 7%.
You can then deduct 7% of your housing expenses - rent, mortgage, etc. but ALSO insurance, PMI, security system, utilities, and even janitorial service if you have a maid (which being Mustachian- you probably don't!)  Note- you can't deduct your home office for the whole year if you only work out it for a month.   http://www.irs.gov/publications/p587/ar02.html#en_US_2012_publink1000226323

You'll probably be paying insurance and mortgage insurance and things anyway, so this isn't taking away profit but rather reducing tax liability for things you'd pay anyway. 

If you have kids, you can "hire" them to help you (collate papers, etc.) for a reasonable amount and basically their allowance becomes a deduction (as long as they are actually helping you with your work.)  You're going to give money to your kids anyway, this helps reduce your liability while teaching them a little about work for money.  (Note: as a writer, the opportunities for this are limited.  As a consultant, I've had them help me with events, i.e., haul coolers, fill with water bottles, load up the car, etc.)

Don't overlook other deductions which reduce your tax liability off the top - such as printer toner, computer depreciation (or other business machine),

You can't really reduce the amount of self employment tax due, but you can reduce the amount of income taxes due.
Worksheet and more info: http://www.irs.gov/publications/p587/ar02.html#en_US_2012_publink1000226331

And check with your accountant to make sure you are maximizing all of your deductions.

Jamesqf

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I am a freelance writer and consultant, and don't overlook business deductions and mileage.  If you go to meet with the professor using a car- mileage. 

And if you have a fairly mustachian car, the mileage rate is likely way more than you actually spend.  And if the occasional trip is done by bike rather than car, I think the mileage rate would still apply.  (Though who would know?)

frugaldrummer

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Quote
They also want to see that your business income increases over the years, or they'll decide that your business is really a hobby, and you can't deduct business expenses.

Actually, your income doesn't have to increase - but if you show no profit, or a loss,  for several years, they may decide it's a hobby.

feelingroovy

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Quote
They also want to see that your business income increases over the years, or they'll decide that your business is really a hobby, and you can't deduct business expenses.

Actually, your income doesn't have to increase - but if you show no profit, or a loss,  for several years, they may decide it's a hobby.

Ah, perhaps my accountant told me that b/c my first year's profit was $10.  (It has increased).  :)