Author Topic: Self-employment taxes took the wind out of my MMM sails - help  (Read 12369 times)

Pixelshot

  • Stubble
  • **
  • Posts: 146
Self-employment taxes took the wind out of my MMM sails - help
« on: November 27, 2013, 07:00:50 AM »
Hi all, I have a fairly complicated situation so thanks for bearing with me. I have recently done some tax projections and realized, to my surprise, that I owe a LOT of taxes (details below). I'm in need of some general advice as to what to -legally- do to curb this and also keep paying off my student loan as fast as possible.

The details:
- my wife works full time. She pulls in about $135k gross pay, we live entirely on this salary
- I do freelance video work for extra (and take care of our 3-yo son) and had a very good year (the main reason behind the "surprise" taxes) - I invoiced about $53k
- I have about $25k cash in the business account which I was hoping to put toward my student loan, and about $10k in our personal savings account as a rainy day fund (but could afford to empty this out if it is warranted)
- my student loans are about $40k (at 5.4%)
- I estimate a tax bill of over $18k

Once I calculate all of our deductions, the gross pay will come down significantly, but suffice it to say that, after the taxes I already paid, I estimate that I now owe about another $18k more in taxes than I projected thanks to a combination of events (my wife stepped up two pay grades, my company earned more than projected, tax rates went up, etc). Good thing I held on to the cash!

So, my questions are:
How do I minimize my tax burden aside from the obvious of finding every possible deduction for the family/business? Does it make sense to use the little bit of cash I will have left over to invest in some more company equipment? (I need a new computer for editing, so I could possibly spend as much as 3-5k on that, plus phone, projector, etc)  Or, would it make more sense to use all of that cash toward the student loan? My goal was to cut the student loan in half this year since I can't stand the idea of renting that money any more than is absolutely necessary. I thought I was going to hit that,  but it's not looking good now (I did pay 20k on it earlier in the year).

Also, would it make sense to dump as much cash as possible into an IRA of some kind? Perhaps opening an IRA as a sole proprietor? If so, where do I start with that?

Lots of questions but I'm trying to revive my inner mustachian now that the wind is out of my sails. Thanks for your time.







randymarsh

  • Handlebar Stache
  • *****
  • Posts: 1374
  • Location: Denver
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #1 on: November 27, 2013, 07:21:40 AM »
You can do a Solo 401k or SEP IRA to defer your taxes now. You can technically contribute more to a 401k than SEP, but at your income level I think the max is the same.

If you need to buy equipment that is another good way to reduce your tax hit. But hopefully the spending increases revenues too. Otherwise you're spending $1 to save 28 cents or so.

https://investor.vanguard.com/what-we-offer/small-business/individual-401k has a good overview of different options.

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #2 on: November 27, 2013, 08:13:09 AM »
thefinancialstudent and Maigahane thanks.

- According to my accountant, I can use a 179 deduction to deduct all of the value of the equipment this year. I did that last year for several things (and now wish I hadn't), but I'm pretty sure that next year will be less than this year based on the work requests I have.

- Is investing in a SEP going to make more sense than using as much of that cash as possible for paying off my student loans?
« Last Edit: November 27, 2013, 08:19:59 AM by Pixelshot »

aglassman

  • Stubble
  • **
  • Posts: 165
  • Age: 33
  • Location: Milwaukee, WI
    • Milwaukee Maven
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #3 on: November 27, 2013, 08:21:11 AM »
Is your business a separate legal entity?

willn

  • Stubble
  • **
  • Posts: 248
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #4 on: November 27, 2013, 09:01:08 AM »
Great job increasing your income!  Be ruthless in your analysis of whether you need the new gear.   It HAS to be justified by generating additional revenue via efficiency or capacity.  It's not a tax issue. You don't have more money by spending a dollar to save a quarter.

You don't mention your wife's tax deferred contributions--is she maxing her 401k?

Tax deductions you already know about, obviously be detailed in record keeping for vehicle expenses, set aside a space in your house that is solely for your business so that it qualifies for the home office deduction.  I think for 2013 the home office rules were simplified, be sure to research so you meet the criteria.

If I were you, I would prioritize that debt.  If you factor in the risk it represents, plus its interest rate, it doesn't make sense to hold it.  Once its gone, your cash flow from your business and your wifes raises  are free to use for building the business. 

brewer12345

  • Handlebar Stache
  • *****
  • Posts: 1386
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #5 on: November 27, 2013, 09:42:46 AM »
You are in a bit of a mess tax wise.  Your wife's income plus your business income puts your household in one of the more painful parts of the tax code: generous bracket, much of the goodies like child tax credits or itemized deductions start going away, etc.  DW and I have been nosing around this region for some time and in your business I would bet that if you are in a state with an income tax I would imagine that between federal, state and self employment taxes your marginal tax rate (what you pay on the next dollar you earn) is around 50%!  The easiest way to cut back on your tax bill is to contribute as massively as allowed to tax deferred retirement accounts.  Have your wife max out her 401k/403b at $17.5k a year.  Set up a solo 401k (hurry and you can get it done this year) and max it out.  In your solo k you can defer 17.5k plus 20% of your business earnings.  With 53k net from the business you could defer about $28k.  This would slice something like $45k off your taxable income right off the top.  Depending on some other factors, that might bring you down to the level of income that would allow you to get back some phased out deductions, credits, etc. that could hugely reduce your tax bill.

The sructure of the tax code also suggests something else: do you really want to work that hard if half your earnings from extra effort get taxed away?  DW and I have decided that we do not, so instead of going hell for leather to get more income, we have made the effort to optimize spending and use every legal method allowed to control our tax bill.

The student loan is not at the lowest rate I have ever seen, but its not atrocious.  Faced with the choice between paying interest on it a little longer or cuting my tax bill possibly in half, I would choose the latter, hands down.  If you really want to kill it and don't quite have the cash, some solo 401k custodians (Fidelity, possibly others) will allow you to borrow against your solo k when you meet certain thresholds.  While you would still have to pay interest and have a loan, the oney you pay on the loan against your solo k is money you get to keep (the interest is added to your account balance).

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #6 on: November 27, 2013, 10:01:35 AM »
Thanks all!  Yes, my business is organized as an LLC, although for tax purposes, it all goes through my SS# anyway so the LLC is mainly for legal protection.

brewer 12345 - I was wondering about that tax bracket thing. Your explanation seems to line up with what I'm experiencing. As I mentioned, I did some projections and thought I was within 2-3 thousand of what I would owe - I didn't factor in the higher tax bracket thing (heaven knows it's nearly impossible for an average guy to figure out).

So, I think what I'm hearing you say is that it's possible to dump nearly all of my $25k in cash into the personal 401k and hence reduce my tax burden back to a manageable level. This is risky, of course, because I will have to empty out my savings BEFORE doing the taxes once my wife's official W2 arrives in January (I have calculated out pretty much exactly what it will say though). If there's a mistake, then I won't have much cash to correct it.  But I guess the suggestion is to forego the student loan payments in lieu of dumping the cash into a 401k so that at least I will keep more of that money in the long run.  Right?

As for the "necessary" business expenses, I was planning to buy a new computer to keep up with the growing demands of work (the new Mac Pro announced recently). Although it is overpriced, I have deemed it a necessary expense but I could possibly live without it for another year.
« Last Edit: November 27, 2013, 10:07:52 AM by Pixelshot »

ShortInSeattle

  • Pencil Stache
  • ****
  • Posts: 576
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #7 on: November 27, 2013, 10:06:48 AM »
I'm in a very similar situation and I just want to say Brewer gave you some great advice.


SunshineGirl

  • Pencil Stache
  • ****
  • Posts: 749
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #8 on: November 27, 2013, 10:09:55 AM »
You just need to have the account open by the end of the year. You have until April 15 to fund it.

ShortInSeattle

  • Pencil Stache
  • ****
  • Posts: 576
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #9 on: November 27, 2013, 10:13:42 AM »
You just need to have the account open by the end of the year. You have until April 15 to fund it.

I believe that is true for a SEP/IRA but not a solo 401(k). Might be worth checking.


brewer12345

  • Handlebar Stache
  • *****
  • Posts: 1386
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #10 on: November 27, 2013, 10:21:33 AM »

So, I think what I'm hearing you say is that it's possible to dump nearly all of my $25k in cash into the personal 401k and hence reduce my tax burden back to a manageable level. This is risky, of course, because I will have to empty out my savings BEFORE doing the taxes once my wife's official W2 arrives in January (I have calculated out pretty much exactly what it will say though). If there's a mistake, then I won't have much cash to correct it.  But I guess the suggestion is to forego the student loan payments in lieu of dumping the cash into a 401k so that at least I will keep more of that money in the long run.  Right?

As for the "necessary" business expenses, I was planning to buy a new computer to keep up with the growing demands of work (the new Mac Pro announced recently). Although it is overpriced, I have deemed it a necessary expense but I could possibly live without it for another year.

What I am saying is that you have to establish the solo 401k before the end of this year.  However, contributions do not have to be made until you actually submit your tax forms (4/15/14 deadline for conributions), which means you have a lot of flexibility to really see what your taxes look like and how much to contribute.  Turbotax generally does a pretty good job with solo k considerations and can guide you if you DIY taxes (which I strongly recommend).  So establish the account pronto, but contributions can wait until tax filing time.  I would back off on the student loan payments in the meantime.  A couple months difference in order to get it right and not stretch your cashflow is worth it.  I also would be a lot more focused on reducing taxes than the student loan.  After all, you pay something like $2k a year in interest on the loan.  If you continue paying that for a few years, but save yourself $10k/year (or more) in income taxes, that is a huge home run.

If you don't need the computer for a year, you should wait.  Not obly is spending money soelly for tax purposes a bad idea, but next year's model will be better, faster, cheaper, and probably be able to polidsh your nuts and serve you a milkshake.

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #11 on: November 27, 2013, 10:29:36 AM »
genius. Thanks.

Where do I start with setting up the 401k? thefinancialstudent suggested Vanguard, which I already use and love

https://investor.vanguard.com/what-we-offer/small-business/individual-401k

but are there specific things I should be looking for? Is my best option the Individual 401k? (as opposed to SEP IRA, or Simple IRA)

brewer12345

  • Handlebar Stache
  • *****
  • Posts: 1386
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #12 on: November 27, 2013, 10:44:17 AM »
I think you want a solo 401k specifically.  It gves the sole proprietor tons of flexibility and for most states of the world it allows you to contribute the most to it.  Choice of broker is up to you.  We went with Fidelity years ago becasue they were the only ones that woudl do it for free at the time.  It apppears that Schwab (who we use for everything else) and Vanguard now do it for nothing.  If you care about the ability to take a loan against the account, check that out.  I know Schwab does not allow it and Fidelity does.  Its not critical for us, but I like having the flexibility so we have stayed with Fidelity.  I find their service to be quite good (equal to Schwab's, which I  hold in high regard).  If Vanguard offers what you need, it might be simplest just to keep it all in one place.

the fixer

  • Handlebar Stache
  • *****
  • Posts: 1037
  • Location: Seattle, WA
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #13 on: November 27, 2013, 11:05:37 AM »
Something several people are implicitly getting wrong is how much business deductions save you on taxes. You save your marginal tax rate plus self employment taxes, minus the one-half deduction. For a taxpayer in the 25% bracket I think this works out to about 40%. So you spend a dollar to save 40 cents, still not getting you ahead but it lets you buy stuff really cheap.

I think you should consider what expenses you expect to have next year, and see if you can move some of them up to this year. A new computer is a good one, even if you don't need it now will you need it a year from now?

This won't save a lot unless you get way too carried away, so this strategy needs to be paired with something else like the a retirement plan.

One more thing: do you qualify for the home office deduction? Did you account for that "expense" in your tax projections?

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #14 on: November 27, 2013, 01:05:17 PM »
Thanks. Yes, I'm calculating a home office deduction (for part of my apartment where I have a desk).

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #15 on: November 27, 2013, 01:43:21 PM »
FYI for anyone reading this, Vanguard Individual 401k plans do not have an option to borrow against the loan (suggested by brewer).

feelingroovy

  • Bristles
  • ***
  • Posts: 294
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #16 on: November 27, 2013, 01:54:41 PM »
I would agree with the solo 401K suggestion to reduce your overall tax burden, but want to mention two things no one else has said. 

And this is a situation where you want a good CPA.  I'm self-employed, and have a CPA, and the following is my understanding.  If anyone can correct me, please do.  My understanding is:

1. If you haven't been making quarterly payments, the IRS will charge a penalty + interest for paying late, even if you pay the full amount you owe in April.  I believe though, that this is based on your total amount owed, so if you wife could increase her withholding now so that you don't owe anything in April, you wouldn't get charged those penalties.  This is the part that would make me nervous.

2. The solo 401K will reduce your federal and state tax, but NOT self-employment tax, aka Social Security + Medicare.  A 401K (or a SEP IRA) is a personal deduction off the front page of the 1040, NOT off the schedule C.  So if after business deductions on the schedule C (home office deduction, office supplies, professional services like your CPA, milage), your schedule C comes to say $40k, even if you put all of that into solo 401K, you'll still owe ~15% of $40,000 for self-employment tax.

the fixer

  • Handlebar Stache
  • *****
  • Posts: 1037
  • Location: Seattle, WA
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #17 on: November 27, 2013, 02:00:57 PM »
It's more complex than that, and I don't know the whole story either, but I'll chip in with what else I know:

You can only be assessed a penalty if you owed money when you filed your return the previous year. If you were due a refund last year, you're okay.

Aside from that, if the taxes you paid during the year through withholdings and quarterly payments totaled up to at least the amount of tax you owed last year (or 110% of the total if you're over some income threshold), you will get no penalty IF your withholdings and quarterly payments weren't gamed in some way (I don't know exactly how this works, but the IRS cautions that you can be due a refund with your tax return and still owe a penalty because you didn't file quarterly payments evenly with income, e.g. do one big payment in January and none for the other three).

Zelda01

  • 5 O'Clock Shadow
  • *
  • Posts: 55
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #18 on: November 27, 2013, 02:19:08 PM »
When I opened up my self employment IRA, I asked the brokerage which type would be better for me.  They said, SEP IRA is easier to set up, Individual 401k allows a person to contribute more.  I decided to set up the SEP IRA, and they said they could help me switch it later if needed.  I do better if I just get the easy option set up immediately, then worry about the ideal later.

My suggestion is, if you are lacking time, call up your favorite broker and set up the SEP IRA now.  Ask if it's possible to change to 401k later.  If you HAVE time, go for the 401k.

Here is a link to calculate how much you can put in the various types:
https://personal.vanguard.com/us/SbsCalculatorController

feelingroovy

  • Bristles
  • ***
  • Posts: 294
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #19 on: November 27, 2013, 03:23:20 PM »


but are there specific things I should be looking for? Is my best option the Individual 401k? (as opposed to SEP IRA, or Simple IRA)

As long as you have no employees, it will allow you to shelter the most income.

SEP IRA only lets you shelter 20-25% of Schedule C profit, but the absolute limit is high (I think $47k).

Simple IRA allows 100%, but only up to $12k.  Also, you had to have set it up by Oct 1.  My understanding is Simple is best when you have employees, so as long as you don't, you're better off with the Solo 401K.

Here is a calculator that compares the contribution limits: http://www.bankrate.com/calculators/retirement/self-employed-401-k-calculator.aspx

brewer12345

  • Handlebar Stache
  • *****
  • Posts: 1386
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #20 on: November 27, 2013, 04:23:22 PM »
I would agree with the solo 401K suggestion to reduce your overall tax burden, but want to mention two things no one else has said. 

And this is a situation where you want a good CPA.  I'm self-employed, and have a CPA, and the following is my understanding.  If anyone can correct me, please do.  My understanding is:

1. If you haven't been making quarterly payments, the IRS will charge a penalty + interest for paying late, even if you pay the full amount you owe in April.  I believe though, that this is based on your total amount owed, so if you wife could increase her withholding now so that you don't owe anything in April, you wouldn't get charged those penalties.  This is the part that would make me nervous.

2. The solo 401K will reduce your federal and state tax, but NOT self-employment tax, aka Social Security + Medicare.  A 401K (or a SEP IRA) is a personal deduction off the front page of the 1040, NOT off the schedule C.  So if after business deductions on the schedule C (home office deduction, office supplies, professional services like your CPA, milage), your schedule C comes to say $40k, even if you put all of that into solo 401K, you'll still owe ~15% of $40,000 for self-employment tax.

Opinions differ, but I strongly suggest that everyone do their own taxes and not hire a CPA.  It saves you money and forces you to do the necessary research so that you become educated.

Others have commented on #1.  As for #2, that is correct: you will owe self employment taxes no matter what you do.

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #21 on: November 28, 2013, 04:37:55 AM »

Opinions differ, but I strongly suggest that everyone do their own taxes and not hire a CPA.  It saves you money and forces you to do the necessary research so that you become educated.

Others have commented on #1.  As for #2, that is correct: you will owe self employment taxes no matter what you do.

How do I calculate those self employment taxes? I understand that if I donate to the 401k, it counts as a business expense (as if I never made the money in the first place, right?). So, the self employment would only apply to the remainder. Right?  According to this calculator, the calculation is made on the "net profit." http://www.bankrate.com/calculators/tax-planning/self-employed-business-tax-calculator.aspx

Also, Feelingroovy mentioned an Oct 1st deadline. When I talked to Vanguard yesterday they said as long as I have the Individual IRA set up by the end of the calendar year, it would count. The Vanguard application says: "Vanguard must receive your Individual 401(k) Plan Adoption Agreement in good order (an employer identification number is required to establish a plan) by the last day of your fiscal year (December 31 for calendar-year plans) in order to make contributions for that year."
« Last Edit: November 28, 2013, 04:46:54 AM by Pixelshot »

Rural

  • Magnum Stache
  • ******
  • Posts: 4841
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #22 on: November 28, 2013, 05:22:38 AM »
Instead of trying to answer your specific question, let me suggest you get a copy of the Form 1040 and the Schedule C instructions (on the IRS website, or I believe they will still mail you a hard copy on request). The first time I did my taxes with self-employment income, I read through those instructions to get the general idea, then did the taxes line by line, reading all of the instructions for each in full as I went to be sure I didn't miss anything. It was not exciting, and it took a while, but I got the taxes done right, to my best advantage (much lower than the previous year with a CPA and with the situation virtually unchanged), and when I was audited a few years later, the IRS determined I was entirely in the right.

Even if you choose to go with a CPA (there are much better ones out there than the one I used, I'm sure), it will do you a world of good to have the general gist, and there's no better way to get the real skinny than to read the actual IRS instructions. I've never had to read the whole thing all the way through at once again, because they list changes each year. It's no fun, that's for sure. But it pays off. I can't calculate my hourly rate for the few hours I spent on the booklet that year, because I'm sill earning it very year, even now at ~20 years later.

brewer12345

  • Handlebar Stache
  • *****
  • Posts: 1386
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #23 on: November 28, 2013, 09:06:27 AM »

Opinions differ, but I strongly suggest that everyone do their own taxes and not hire a CPA.  It saves you money and forces you to do the necessary research so that you become educated.

Others have commented on #1.  As for #2, that is correct: you will owe self employment taxes no matter what you do.

How do I calculate those self employment taxes? I understand that if I donate to the 401k, it counts as a business expense (as if I never made the money in the first place, right?). So, the self employment would only apply to the remainder. Right?  According to this calculator, the calculation is made on the "net profit." http://www.bankrate.com/calculators/tax-planning/self-employed-business-tax-calculator.aspx

Also, Feelingroovy mentioned an Oct 1st deadline. When I talked to Vanguard yesterday they said as long as I have the Individual IRA set up by the end of the calendar year, it would count. The Vanguard application says: "Vanguard must receive your Individual 401(k) Plan Adoption Agreement in good order (an employer identification number is required to establish a plan) by the last day of your fiscal year (December 31 for calendar-year plans) in order to make contributions for that year."

You still have to pay self employment taxes on solo 401k contributions.  Spend some quality time with your tax return and this will all become more intuitive.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8761
  • Registered member
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #24 on: November 28, 2013, 03:05:23 PM »
http://www.mrmoneymustache.com/forum/antimustachian-wall-of-shame-and-comedy/

To a mustachian, the extra 6-7% self employment taxes should be neither surprising nor significant to your savings rate

Jamesqf

  • Magnum Stache
  • ******
  • Posts: 4047
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #25 on: November 28, 2013, 10:18:53 PM »
To a mustachian, the extra 6-7% self employment taxes should be neither surprising nor significant to your savings rate

Nor are they "extra" taxes: it's what would show up as SS/Medicare if you were an employee, but the half the employer has to pay before figuring your gross pay, so you don't actually see it.

lovesthesea

  • 5 O'Clock Shadow
  • *
  • Posts: 11
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #26 on: November 29, 2013, 03:57:47 PM »
Thanks for all the great info and advice here.  It's very helpful to me too.

feelingroovy

  • Bristles
  • ***
  • Posts: 294
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #27 on: November 29, 2013, 08:37:06 PM »

I understand that if I donate to the 401k, it counts as a business expense (as if I never made the money in the first place, right?). So, the self employment would only apply to the remainder. Right?  According to this calculator, the calculation is made on the "net profit." http://www.bankrate.com/calculators/tax-planning/self-employed-business-tax-calculator.aspx

No.  401K contributions do not count as a business expense as if you never made it in the first place.

Yes, self employment tax is calculated on the net profit, but 401K donations are not counted as business expenses.  They are adjustments to your Adjusted Gross Income on the front page of the 1040. 

Schedule C is where you list your *business* income and expenses, and therefore calculate profit.  401K contributions do not go there.

(The exception is any 401K contributions the business made to any *employees'* retirement accounts.  Those are business expenses, but that doesn't apply to you, since you're the owner.  This is why it gets complicated).

I agree with Rural's advice to spend time with the schedule C and the 1040.  I would also recommend getting a book from the library on Small Business Taxes.  I do have a CPA and believe he has saved me more than he has cost me over the years (I have employees and therefore have to run payroll and collect and submit sales tax), but I still educate myself.  He said I'm his only client who actually checks all his numbers.


Also, Feelingroovy mentioned an Oct 1st deadline. When I talked to Vanguard yesterday they said as long as I have the Individual IRA set up by the end of the calendar year, it would count. The Vanguard application says: "Vanguard must receive your Individual 401(k) Plan Adoption Agreement in good order (an employer identification number is required to establish a plan) by the last day of your fiscal year (December 31 for calendar-year plans) in order to make contributions for that year."

Right.  I said the Oct 1 deadline is for a SIMPLE IRA.  That's different.

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #28 on: November 30, 2013, 05:02:04 AM »
Thank you all for your advice! Rest assured I'm spending lots of time reading the documents but haven't covered it all yet so your information is invaluable to at least get me started in the right direction. I do have a CPA who I'm scheduled to meet with next week.

(The exception is any 401K contributions the business made to any *employees'* retirement accounts.  Those are business expenses, but that doesn't apply to you, since you're the owner.  This is why it gets complicated).

It is my understanding that the business can contribute to my Individual 401k and thus it is deductible from my self employment income. There is a limit to the contribution amount (and the calculator is somewhat confusing), but I am told by the Vanguard person that I can contribute both as an individual AND as a company and it is up to me to decide how much from what pile. Moreover, as long as I set up the 401k by the end of the year (it will be backdated for Jan 1st) then I can wait until April to actually make the contribution when I will know more about the tax codes, etc.  I don't know if this wait-till-april thing also applies to the company contributions, but that is something I will be sure to clarify (and post back here) when I have figured it out.

  I would also recommend getting a book from the library on Small Business Taxes.

I will. Any specific recommendations?
« Last Edit: November 30, 2013, 05:16:09 AM by Pixelshot »

feelingroovy

  • Bristles
  • ***
  • Posts: 294
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #29 on: December 01, 2013, 08:24:18 PM »
I could be wrong about the business's side of the 401K contributions being business expenses.  That's what I understood for a SIMPLE, but maybe the rules are different, or maybe I've got it mixed up. 

And, no specific book recommendations.  I recently read a Nolo book and a JK Lasser book (both seem to be reference book series).  When I need to learn about something, I just go to the library and get 6-8 books on that topic.  Read the ones that make sense and skip the rest.


iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #30 on: December 01, 2013, 09:02:54 PM »
If you are a sole proprietor, and you make Employee and Employer contributions to your Individual 401(k), both are totaled on Line 28 of the 1040 (and thus reduce your individual taxes).  Neither the employee nor the employer contribution are deductible as business expenses on the schedule C, and thus do not reduce your self employment taxes.  So, yes, the total contribution helps your tax situation, they just don't help the part of your taxes that is self employment taxes.

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #31 on: December 02, 2013, 04:03:23 PM »
If you are a sole proprietor, and you make Employee and Employer contributions to your Individual 401(k), both are totaled on Line 28 of the 1040 (and thus reduce your individual taxes).  Neither the employee nor the employer contribution are deductible as business expenses on the schedule C, and thus do not reduce your self employment taxes.  So, yes, the total contribution helps your tax situation, they just don't help the part of your taxes that is self employment taxes.

Thanks iamlindoro.

The Vanguard web site says that the Individual 401k employee contributions (up to the max limit) are:
"Deductible as a business expense and not required every year."
https://investor.vanguard.com/what-we-offer/small-business/individual-401k

Yet this doesn't jive with what you're saying. Also, I don't know where to itemize this deduction. Looking at my Schedule C from last year, one possible item in the "expenses" category is line 19 (pension and profit-sharing plans) but that doesn't sound right either.


iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #32 on: December 02, 2013, 05:51:18 PM »
As always on the internet, it's a matter of who you feel you can trust/believe.  When I set up my Individual 401(k) I looked into this as well, and found the following:


http://taxes.about.com/od/soleproprietorships/a/self-employment-tax.htm

Quote
Similarly, above-the-line deductions for health insurance, SEP-IRA contributions, or solo 401(k) contributions will not reduce your self-employment tax either; those deductions only reduce the federal income tax.

Another (admittedly it's a back and forth in a forum)-- The third to last reply, from a supposed CPA, may be of note:

http://www.taxalmanac.org/index.php/Discussion:Self_Employed_401K_contributions

Quote
I would agree with Dhtax, neither the Sch C owner's "employee deferral" portion nor the employer contribution is deductible directly on Sch C, both are deductible on line 28 of Form 1040. Neither portion will reduce his SE taxable income. The advantage of an individual 401K over a SEP is that it allows the taxpayer with no employees to arrive at the maximum deduction at a lower Sch C net profit than will a SEP.

Also see:

http://www.accountantforums.com/solo-401k-and-1040-a-t15528.html

Of course, neither these discussions nor the text on the Vanguard page are official advice from an accountant, but if you do solicit advice from an accountant (as you probably should in a murky environment such as this), definitely let us know what advice you get.

iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #33 on: December 02, 2013, 06:08:09 PM »
Another good link that may clarify or further confuse the issue:

https://www.fidelity.com/retirement-ira/small-business/self-employed-401k/overview

Click on "Learn more about the tax advantages of self-employed 401(k)s."

Quoted:

Quote
If your business is unincorporated, you can deduct contributions for yourself from your personal income.
If your business is incorporated, you can generally deduct contributions as a business expense.


Argyle

  • Pencil Stache
  • ****
  • Posts: 909
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #35 on: December 02, 2013, 06:34:57 PM »
Maybe I've misunderstood something here, but you say that you owe ~$18,000 in taxes on your $50,000-something income.  But that's not really the situation, is it?  It's that you and your wife find that you both owe ~$18,000 in taxes on your combined ~$185,000 income.  You wouldn't owe that much on ~$50K alone.  It's only when it's combined with your wife's income that such a high tax rate applies.

If you keep your finances separate, you may want to adjust accordingly.

If you don't keep your finances separate, you should also look into what she could be doing to shelter her income.  Two people sheltering are better than just you sheltering.  You may have more opportunities because you're self-employed and lower-income, but she should also maximize hers.  And you shouldn't be liable for that whole $18,000.  When you say you "live off her salary," that's not really the case.  You mean that you both live off an amount equivalent to her salary. 

cdub

  • Stubble
  • **
  • Posts: 167
    • Mortgage Payoff Club
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #36 on: December 02, 2013, 06:42:08 PM »
Talk to a CPA -  but I've incorporated my freelance business and pay myself through a payroll service - thus eliminating the self-employment taxes. The business pays taxes too - but you can also then pay yourself a small portion of the business profits via a dividend to shareholder which is taxed at 15%.

But then again I'm also bringing in $150-182k in my freelance business so it makes MUCH more sense in that situation.

Get a good CPA before you do anything. That's what I would recommend.

I'm also setting up a Individual 401k soon - I was doing a SEP-IRA but I think an Indv 401k will be better.




Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #37 on: December 02, 2013, 07:18:02 PM »
...Of course, neither these discussions nor the text on the Vanguard page are official advice from an accountant, but if you do solicit advice from an accountant (as you probably should in a murky environment such as this), definitely let us know what advice you get.

Thanks to all for your invaluable advice. Yes, I plan to meet with my accountant soon and will post more info when I do.

Argyle - you are correct. Our combined gross income is about 180k (although that is before deducting any business expenses) and the tax owed is after counting what she has already paid this year. Last year, with about $40k of business invoices (compared to $52k of this year), the amount withdrawn from her paycheck covered all we owed for both fed and state with a 3k refund. But, it seems that the little things have added up to a big number. A couple of steps up in her pay, a few thousand in added invoices, a step up into higher marginal tax rates, etc...  ouch.

I don't think there's anything more we can do to withdraw from her paycheck. We're already maxing the 401k and taking out the allowable deductions from her paycheck (child care expenses, transportation, etc). We do give a lot to our church so that helps.

Argyle

  • Pencil Stache
  • ****
  • Posts: 909
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #38 on: December 05, 2013, 09:02:13 PM »
If you can't shelter any more of your wife's income, she should be paying some of that $18,000 bill, if I understand correctly -- is that not so?  Since it was her income that incurred some of it.

Pixelshot

  • Stubble
  • **
  • Posts: 146
Re: Self-employment taxes took the wind out of my MMM sails - help
« Reply #39 on: December 18, 2013, 06:16:28 PM »
true, but we're sharing the load for everything - she pays all of our living expenses through her paycheck.