Tax strategies for self-employment income
Dear Liz: I’m 25 and trying to maximize my tax savings and retirement contributions. I currently have two jobs: One is the typical salaried position with taxes withheld where I earn $45,000 a year, while the other is self-employed work I do on the side that grosses about $7,000 a year. Currently I have a Roth IRA that I max out and a 401(k) that gets the equivalent of 13% of my salary when combined with my employer’s contribution.
Given that I don’t get a refund on April 15 and end up having to pony up a lot of money, is there a way for me to set aside my self-employment income into a retirement account such that I can just bypass all taxes on it, including payroll taxes? Would a traditional IRA work that way? If so, how would the IRS know that I’m putting money aside from my self-employment income and not from my regular day-job income?
Answer: To answer your last question first, the IRS doesn’t really care where the money comes from when you pay your tax bill. It mostly just cares about getting paid.
That said, you probably won’t be able to avoid self-employment taxes on your side business income, although you should be able to reduce or even eliminate owing income taxes on the money, said Eva Rosenberg, an enrolled agent who writes about taxes at TaxMama.com. (Self-employment taxes are your contributions to Social Security and Medicare.)
“The only way to reduce self-employment taxes is to reduce self-employment income,” Rosenberg said. “Putting money into retirement plans of any kind will only reduce income taxes.”
One way to reduce your self-employment income is to incorporate and then have your corporation contribute to your retirement plan directly, “thus wiping out most of your wages,” Rosenberg said. “However, the cost of incorporating and the annual filing and fees related to all that will certainly exceed your self-employment taxes on $7,000.”
What might make more sense if you want to reduce your income taxes is to contribute the maximum $5,000 to a traditional IRA, which offers a tax deduction for contributions, instead of funding a Roth, which does not. Even though you have a retirement plan at work, you can deduct your full contribution if your modified adjusted gross income is under $56,000.
Another option is a solo 401(k), which would allow you to put aside up to 100% of your compensation (although again, you would still owe self-employment taxes on that compensation).
Also, if you expect to owe more than $1,000 at tax time, you should be making quarterly estimated tax payments instead of waiting until April 15 to pay your tax bill.
Where to get FICO scores
Dear Liz: You recently wrote that it wasn’t possible to get all three of your FICO scores. In fact, you can get all three credit bureaus’ FICO scores at the same time at https://www.creditchecktotal.com on a one-time or subscription basis. I have the subscription at $29.95 per month and I can run all three as often as I want. They also have online inquiry to two of the three bureaus.
Answer: You’re getting access to credit scores at that site, but they’re not the FICO scores that most lenders use.
CreditCheck Total is a credit monitoring site run by the credit bureau Experian, which stopped selling FICO scores to consumers in 2009, although it continues to sell them to lenders. Instead, Experian typically sells consumers its own in-house credit score, the PLUS, which is no longer used by lenders. As the site says, “Lenders and insurers use several different credit scoring models, so don’t be surprised if your lender gives you a score that’s different from the PLUS Score you receive online.”
Currently the only place to buy two of your three FICO scores is at https://www.myfico.com.
Pay off student loan or save for down payment?
Dear Liz: Next year we will be shopping for a house in the $150,000-to-$200,000 range and hope to have $20,000 to $30,000 saved for a down payment. We have about $75,000 in student loans we are paying down. Would it be better to eliminate, say, one $3,000 student loan early or keep the $3,000 for a bigger down payment?
Answer: Eliminating such a small loan is unlikely to have a big effect on the size of the mortgage you’ll get, so you’re probably better off boosting your savings for your down payment. Don’t forget to save a bit extra so you have enough cash to cover closing costs and the inevitable repairs and maintenance required with homeownership.
Liz Weston is the author of “The 10 Commandments of Money: Survive and Thrive in the New Economy.” Questions for possible inclusion in her column may be sent to 3940 Laurel Canyon Blvd., No. 238, Studio City, CA 91604 or via asklizweston.com. Distributed by No More Red Inc.
