Tax question about contributing to a ROTH IRA

[merlin3942]

Hoping someone here can help with a tax question - I've not been able to get through to any "tax question advisors" at IRS, or at my tax prep software support (H&R Block). My only "earned income" for 2020 was classified as "nonemployee compensation income", earned from being a "guest lecturer" at a number of work-related workshops (via Zoom, actually!) in 2020. Based on those earnings, I went ahead and made a ROTH IRA contribution for the maximum allowable amount several weeks ago ($7,000 in my case), based on my nonemployee compensation income of just under $10,000. However, my H&R Block tax software program is now telling me that based on the income I declared for 2020, I am not eligible to make any ROTH IRA contribution, and must withdraw it (and any interest earned so far), or be liable for a penalty. That just doesn't seem correct .... anyone know for sure?

 

[cathy63]

Report the 1099-NEC income on a Schedule C and the dire warnings should go away. You will have to pay self-employment tax on your earnings, but since you intended to make money and have done it multiple times, that's the right thing to do.

 

[GalaxyBoy]

I would expect you are declaring the income on your 1040, and that you have a W-2 or 1099 showing the income. If not, I would expect tax software to give you the results you describe.

[edit to add: A better answer was posted above as I was typing.]

 

[merlin3942]

Report the 1099-NEC income on a Schedule C and the dire warnings should go away. You will have to pay self-employment tax on your earnings, but since you intended to make money and have done it multiple times, that's the right thing to do.

Thanks much! I'll give that a shot. I never thought about the self-employment tax, but that makes sense as well.

 

[SecondCor521]

What @cathy63 wrote is correct.

In addition, if you report on Schedule C, the IRS also expects you to deduct any reasonable and necessary expenses related to the production of that income. This will reduce your SE taxes, but I think it also reduces the amount of income eligible for Roth contributions.

 

[merlin3942]

What @cathy63 wrote is correct.

In addition, if you report on Schedule C, the IRS also expects you to deduct any reasonable and necessary expenses related to the production of that income. This will reduce your SE taxes, but I think it also reduces the amount of income eligible for Roth contributions.

Got it - thanks! I actually did have to invest in a new computer, webcam, external USB mic, LED photography light kit, and a wifi router extender in order to be able to do those Zoom sessions. May try deducting at least some of that, up to the point where I can still contribute the max to my ROTH.

 

[SecondCor521]

Got it - thanks! I actually did have to invest in a new computer, webcam, external USB mic, LED photography light kit, and a wifi router extender in order to be able to do those Zoom sessions. May try deducting at least some of that, up to the point where I can still contribute the max to my ROTH.

I understand the motivation. But I will add that the IRS expects you to take all deductions to which you're entitled and not to shoot for a certain amount of net income.

If all of your deductions mean your applicable income for Roth contributions is only (for example) $6K, then the right thing to do would be to take all those deductions and withdraw the $1K excess plus applicable earnings rather than ignore some of the deductions in order to max out the Roth.

 

[merlin3942]

I understand the motivation. But I will add that the IRS expects you to take all deductions to which you're entitled and not to shoot for a certain amount of net income.

If all of your deductions mean your applicable income for Roth contributions is only (for example) $6K, then the right thing to do would be to take all those deductions and withdraw the $1K excess plus applicable earnings rather than ignore some of the deductions in order to max out the Roth.

I had no idea that NOT maximizing deductions, in order to maximize a ROTH contribution, was "frowned upon" by the IRS. I just assumed the more I pay upfront in taxes now, the happier they would be ... thanks for tip!

 

[cathy63]

I had no idea that NOT maximizing deductions, in order to maximize a ROTH contribution, was "frowned upon" by the IRS. I just assumed the more I pay upfront in taxes now, the happier they would be ... thanks for tip!

The IRS' main concern with Sched C expenses is with people who are trying to game the system to maximize their earned income tax credits rather than their Roth IRA contributions. Not to say that they don't care about people in your situation too, but EITC fraud is a much bigger problem overall.

 

[pb4uski]

Where does it say that one MUST take a deduction that one is entitled to take? I know you must report all income but I've never seen the inverse.

 

[SecondCor521]

Where does it say that one MUST take a deduction that one is entitled to take? I know you must report all income but I've never seen the inverse.

See the answer to the second and third questions here:

https://www.eitc.irs.gov/tax-prepar...ed-income-self-employment-income-and-business

 

[cathy63]

Where does it say that one MUST take a deduction that one is entitled to take? I know you must report all income but I've never seen the inverse.

The "must take deductions" rule is specific to self-employed individuals filing Schedule C. You can ignore deductions on Schedule A if you want to. Here's the IRS FAQ on it.

https://www.eitc.irs.gov/tax-prepar...ed-income-self-employment-income-and-business

Q: I know self-employed individuals have to report all income. My question is about deducting expenses. Are taxpayers required by law to claim all expenses pertaining to their business?

A: Yes. A self-employed individual is required to report all income and deduct all expenses. Revenue Ruling 56-407, 1956-2 C.B. 564, deals with the issue of taxpayers not taking all allowable deductions in computing net earnings from self-employment for self-employment tax purposes. 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.

Net earnings from self-employment are included in earned income for EITC purposes. It is defined by cross-reference to the definition of net-earnings from self-employment under I.R.C. §1402(a). This ruling applies equally to the EITC. CCA 200022051 also provides insight regarding deduction of Schedule C expenses.

edit: cross-posted with SecondCor521. We both referenced the same page.