Low Income Roth or Not ?

[Sunset]

Looking for advice on which action is better and am I missing something important money-wise in my choices:

This year I earned approximately $3,000 from self employment, to keep an old employer's system running.

In past when I'd earn over $10K , I'd deduct expenses and with leftover income contribute to my self-401K-Roth, plus my regular Roth.

Now with $3,000 earnings I'm wondering which is smarter:

(1) Deduct $2K expenses and pay FICA and income tax at 22% on $1K, then contribute 1K to self-401K-Roth, and 1K to regular Roth.

(2) Skip deducting expenses so pay FICA and income tax at 22% on $3K, then contribute 3K to self-401K-Roth, and 3K to regular Roth.

(3) Spend and extra $1K on expenses, so I deduct away the entire earnings, pay no tax on self-employment.


I will be doing IRA -> Roth conversions as well, so won't be doing any IRA contributions.

 

[pb4uski]

Find a 3-sided coin and flip it? Candidly, with the magnitude of the numbers involved any would be fine... not a compelling winner.

 

[Sunset]

Find a 3-sided coin and flip it? Candidly, with the magnitude of the numbers involved any would be fine... not a compelling winner.

True, any choice will not lead us to the poor house.

Like getting a sale on eggs/milk which does not matter in the scheme of things, it still appeals to my cheap/optimization character.

 

[RunningBum]

1 or 3. Your tax rate is a little high to ignore the deductible expenses. Also, taxable savings is a pretty good alternative to a Roth, especially if you hold forever so that heirs get stepped up basis.

As you've both said, the amount is trivial so it barely matters.

 

[SecondCor521]

My understanding is that the IRS prefers that you deduct your actual expenses and not skip doing so in order to adjust your income the way you might prefer.

So my answer would be:

1. Deduct your actual expenses the way the IRS prefers.

2. Don't spend additional money on expenses just to get the tax deduction.

3. Contribute as much as you can to your Roth IRA up to the annual contribution limits and limits based on your income (and your partner's income, as applicable).

 

[aaronc879]

I wonder if since this is such a low income from self employment if it could be filed as "other income". Then you owe no FICA but can't deduct expenses to drop income. You could put your whole $3K income into tax deferred savings. Just a thought, not sure about the IRS rules.

 

[SecondCor521]

I wonder if since this is such a low income from self employment if it could be filed as "other income". Then you owe no FICA but can't deduct expenses to drop income. You could put your whole $3K income into tax deferred savings. Just a thought, not sure about the IRS rules.

It is the character of the income, and not it's amount, which determines where it should be reported on the tax return. Self employment income should be reported on Schedules C and usually SE. Hobby and other income should be reported on the Other Income line, which lives on Schedule 1 line 8 this year.

However, it is my understanding that Other Income does not qualify as earned income for the purposes of contributing to tax deferred accounts, so if they chose to report it as Other Income, then they could not make a contribution to a Roth IRA (for example) because of that income.

 

[Sunset]

My understanding is that the IRS prefers that you deduct your actual expenses and not skip doing so in order to adjust your income the way you might prefer.

....

At first I considered how that seems so silly, that the IRS does not want more tax.
It turns out people do miss claiming deductions in order to benefit from the generous Earned Income Tax Credit.

It appears to be related to Ruling 56-407, 1956-2 C.B. 564 , and "Rev. Rul. 56-407 held that under § 1402(a) ... every taxpayer (with the exception of certain farm operators) must claim all allowable deductions in computing net earnings from self-employment for self-employment tax purposes."

I'm not sure if there is exception to the ruling, as I certainly won't be claiming earned income tax credits, as our income is too high.

However, I suppose one could argue that by not claiming deductions, I'd get a $1.00 more in SS (or some such amount) and that this in itself is gaming the system if I live a very long life.

 

[Sunset]

I appreciate everyone's input, and especially considering the rules. I will do the normal thing:

(1) Deduct $2K expenses and pay FICA and income tax at 22% on $1K, then contribute 1K to self-401K-Roth, and 1K to regular Roth.