Taxes for the Self Employed - Help!

[laurence]

O.K., so DW and I are trying to figure out how much tax she is supposed to send the gubmit as a consultant. After using the different calculators, reading different sites, trying to figure out the IRS (ha!) we have values ranging from 50% of her money to all of it plus selling our daughter into slave labor. I am officially hyperventilating at this point. Can someone who's gone down this road help explain just how much you owe? Just some examples and a ballpark? We might be so screwed....

[samclem]

Laurence,

Disclaimer: Not an expert by any means.

I assume you are talking about estimated taxes for 2006, right? (not how much you owe for LAST year).

There are several ways to compute estimated taxes. Most involve estimating how much you will earn, then sending in the periodic payments. If you guess wrong--you owe a fine. Another acceptabe method (and what I do) is to assume you'll make in 2006 exactly what you made in 2005. Your periodic payments will be 1/4 of the taxes due on that amount. Here's the good part--you cannot owe a fine if you do this, regardless of how much more you earn in the present year than in the previous year. Obviously, you'll have to pay taxes based on whatever you actually earned when you file the return, but no penalties will be due.

Sometimes this will result in paying too much in and getting it back in April, but it's worth it to me to be abe to forget about it. Other tips: TaxCut handled my estmated payments computaton well. The federal government's automated system for taking these payments from your checking account works well, after you jump through the hoops of setting things up.


Other ideas: If she's doing this consulting as a sole proprietor, she can set up a "Solo 401K" to reduce her taxes a lot. And, she can even hire you to do work, and you can contribute to a SOLO 401K (spouses are the ony employees allowed under this scheme). These are easy to set up, and cheap.

[eridanus]

You first need to figure out your safe harbor amount. It's based on what you (she) paid in taxes for 2005.

At the minimum, you'll likely pay 15% for the self-employment tax. You can reduce that through various standard business deductions (business supplies, fringe benefits, etc.) but it's a good start.

Go to eftps.gov, sign up, and give them a bone this week if you're really worried.

[laurence]

Thanks, doing the research now.

[retire@40]

Quote:

Originally Posted by samclem ...Another acceptabe method (and what I do) is to assume you'll make in 2006 exactly what you made in 2005.* Your periodic payments will be 1/4 of the taxes due on that amount.* Here's the good part--you cannot owe a fine if you do this, regardless of how much more you earn in the present year than in the previous year...

You won't owe a fine even if you must pay your estimates based on the 110% safe harbor rule?

[Martha]

I think Fairmark has some of the clearest explanations of how to figure your estimated taxes and the 90%, 100% and 110% rules: http://www.fairmark.com/estimate/howmuch.htm

retire@40 alluded to a 110% rule: The prior year safe harbor requires a payment of 110% of the prior year's tax (not just 100% of the prior year's tax) if your adjusted gross income for the prior year was over $150,000 ($75,000 if you are married and filed separately).

[d]

Quote:

I am officially hyperventilating at this point. ... We might be so screwed....*

a Keogh or similar tax deferred plan might help ...

[macdaddy]

This thread sparked a question in my head. Say I am a physician in private practice with an office staff and my wife is unemployed, which basically means she spends (at least) 20 hours per week assisting me with errands, planning out scheduling, etc (things I would otherwise pay to have done). Can I put her on the payroll as a "consultant" for 40k per year, thereby reducing my own income by 40k per year and not paying taxes on it, and have her put all 40k into a 401(k) for her, thereby not paying any taxes on it... does this make sense?

[laurence]

Geeze, it looks like we'll be handing over ~43% of what she makes to the Feds, plus another 5% to California. That's depressing.

[d]

Quote:

Can I put her on the payroll as a "consultant" for 40k per year, thereby

... it's been too long since i had to worry about such things, but i do believe there are advantages to doing this ... perhaps someone with more current knowledge can assist.

[LOL!]

Quote:

Originally Posted by macdaddy Can I put her on the payroll as a "consultant" for 40k per year, thereby reducing my own income by 40k per year and not paying taxes on it, and have her put all 40k into a 401(k) for her, thereby not paying any taxes on it... does this make sense?

Absolutely yes.* But I wouldn't call her a consultant.* I would call her an administrative assistant.* She could put her $15K into a 401(k).* If her employer (you) contributed the other $25K, the employer would have to treat all employees in a similar fashion.

Ever noticed all the TV commericals with the children of business owners in them?* Think of all the car dealers, mattress dealers, furniture dealers, plastic surgeons, dentists, etc that have their kids featured.* Can you say Roth IRA?

As for taxes, are you filing jointly?* Then there are those safe harbor rules.* What I do is simply have my employer withold enough out of my W2 income to cover the taxes on my self-employment consulting income.* To figue out how much tax will be owed, it's pretty simple to re-run TurboTax with the expected self-employment income.* Do not rely on any web site calculator.

So I would go for meeting the safe harbor rules plus the FICA/Medicare taxes.* If spouse self-employed income is not significant, just overwithold on your paycheck and you are all set (and no nasty surprises come April 15th).

[macdaddy]

What are the safe harbor rules? If the spouse only earns 15k in total salary can she contribute 100% of it into a tax deferred 401(k)? If yes, wouldn't this mean she has zero taxable income and thus ends up owing no taxes? That's how I see it.

The only downside I can see is that social security taxes would be due on the 15k but that seems relatively minor in comparison.

[LOL!]

Safe harbor (i.e. how to avoid a penalty) rules: http://www.irs.gov/instructions/i2210/ch01.html#d0e143


And yes, if one has $15K in income, you still owe FICA and medicare, but could put the whole $15K into a 401(k) if the employer allows 100% contribution. Many company plans do not allow 100%.

My spouse (not self-employed) contributes $20K to her 401(k) which is a BIG chunk of her salary.

As for Mrs Laurence's 43% tax hit, she needs to set up a self-employed retirement plan to shelter some of that income. A Keogh, a SIMPLE IRA, ... something.

I have self-employment consulting income. Since my W2 job salary exceeds the FICA limit, I do not have to pay FICA (at 15.3%) on the consulting income. I do pay 1.45% medicare tax.

[farmerEd]

Quote:

Originally Posted by Laurence O.K., so DW and I are trying to figure out how much tax she is supposed to send the gubmit as a consultant.* After using the different calculators, reading different sites, trying to figure out the IRS (ha!) we have values ranging from 50% of her money to all of it plus selling our daughter into slave labor. I am officially hyperventilating at this point.* Can someone who's gone down this road help explain just how much you owe?* Just some examples and a ballpark?* We might be so screwed....*

Don't forget that having a business (and if she is a consultant that's what she is), there are all kinds of deductions you can take to offset your income...imo, its OK to be agressive on the deductions, but don't try to hide the income...being agressive on deductions gets you a penalty...hiding income gets prison time.

If she plans on being in business long, considering setting up a "C" corp, and give it a different tax year than your personal return...gives you incredible flexibility to shift income and expenses around from year to year, all legally...lots of other advantages too (though that was 15 years ago for me so things probably changed).

[brewer12345]

Quote:

Originally Posted by Laurence Geeze, it looks like we'll be handing over ~43% of what she makes to the Feds, plus another 5% to California.* That's depressing.*

Laurence, call up Fido and ask about a solo 401k. It is free to set up and administer with them, and they make it very easy. You can chuck up to $40k a year into the account and avoid all income taxes (still gotta pay payroll taxes).

[samclem]

Laurence,
I second Brewer's comment: My solo 401K is with Fidelity and they made it very simple. TD Waterhouse (now TD Ameritrade) was the other place I looked at that has low fees for these accounts.

The 43% hurts, but I suspect it stings most because you are seeing the numbers without the anesthetizing effect of automatic withholding. If she were an employee instead of a contractor, she'd still be paying 28% (income tax) + 6.2% (SS) + 1.45% (medicare) = 35.65%. One small bit of good news: The 1/2 of SS and medicare taxes she pays as the employer is tax deductable, so instead of being 7.65% total, it will actually cost you just 6.27% .

[Martha]

When your income from employment is dropping it is really a pain to calculate estimated taxes. We used to always use the safe harbor and simply withheld enough to cover 110% of what we paid in the prior year. Last year my earned income dropped substantially, while our capital gain income increased, so we couldn't withhold enough and we had to pay estimated taxes. We are doing our best to calculate based on what we expect to have for income. Same this year. For the past year and a half I have been dedicating all my income to: employee portion of health insurance premiums plus sums in a healthcare reimbursement account, maxing the 401k, and the rest to taxes. I kind of enjoy working part time, but it would be nice to get a check. But the price would be bigger estimated payments.

Laurence, did you calculate using the 100/110% safe harbor rules? If so, you might be over paying if your total income will be less this year. Might be better than underpaying though.

[laurence]

I will definitely check the safe harbor rule, and we'll see Fido about a solo 401(k). It might be possible next year to put all her money into it, but this year we need it for groceries! I just feel bad for DW working that hard to take home so little, but you are right, it's because we are seeing it as one big lump, not as a thousand paper cuts.

[TromboneAl]

Quote:

Can I put her on the payroll as a "consultant" for 40k per year.

If you can find a valid way to employ her and pay her a reasonable amount, there are great advantages in this. I employed wife to do the payroll (see the irony here?), and daughter to clean office, do proofreading. Wife made $12,000, daughter $600 per year.

As a result, we had a medical plan, and all healthcare costs were deductible. Wife could contribute to a Roth.

Laurence: It might be worth a visit to an accountant to show you the ropes for this first year. You'll probably save more than it will cost.

Another tip: Do your taxes (or at least calculate them) on Jan 1, and adjust the Jan 15 estimated payment accordingly.

[TromboneAl]

Funny story related to this: DW went down the accountant's office to get a lesson on how to do the payroll taxes. She was tutored by an assistant named Mary. While they were working, the accountant's dog, named Sadie, was in the office.

A week later my wife called with some questions, but got the names mixed up, and asked "I have some questions about the payroll, could I talk with Sadie, please?"

We still laugh about this!