-
Question about (legally) reducing taxable income
Looking for advice from our SW gurus. Any help would be seriously appreciated!!!
Major questions:
-Can I contribute to a Traditional IRA and a 401k in the same year and deduct the full amount invested from my taxes?
Example: IRA contribution: $5,000, 401k amount: $1,000...Will I be able to claim the full $6,000 as deductible from my income?
-Can I 'protect' my few months of dancing income from the high tax rate incurred by ICs by putting my money into a traditional IRA and HSA?
Example: IRA contribution: $5,000, HSA contribution: $3,350 (max), thus reducing my taxable income by about $8,000
Details of my situation:
I danced for the first few months of the year and deposited that money into my bank account.
I got a job halfway through the year and am now depositing that money into my bank account. I make enough from that job to cover all of my bills without having to dip into savings, which frees up the money I put into the bank from dancing for those few months. Obviously, I'm having taxes taken automatically out of my paychecks now. I'm also contributing 12% to my employer-sponsored 401k.
Is it possible for me to reduce that 30% taxable bit (my three months of dancing income this year) by putting that money into an HSA and a traditional IRA? Or, is the IRS looking at my total income for the year (not splitting out IC taxable income + employment taxable income), which would nullify my efforts to 'protect' myself from that ~30% IC tax rate? And lastly, am I even allowed to use BOTH my traditional IRA and 401k contributions to reduce my taxable income for the whole year?
-
Re: Question about (legally) reducing taxable income
I'm not sure about the traditional IRA, but you can increase your contributions to your 401k, which will reduce your taxable income. Your plan administrator can probably tell you the maximum amount you can deduct.
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
eagle2
I'm not sure about the traditional IRA, but you can increase your contributions to your 401k, which will reduce your taxable income. Your plan administrator can probably tell you the maximum amount you can deduct.
I'm less concerned about lowering my total taxable income, and more interested in lowering the part of my income that will be taxed at 30%. Do you know if those will be separate tax considerations, or grouped into a lump sum to be taxed? Like, if I were to put all of my dancing income from this year into tax-deductible accounts (HSA and t-IRA), then will I only owe taxes on my employment-based income?
-
Re: Question about (legally) reducing taxable income
I'm pretty sure you will be taxed on one lump sum for the year, so lowering your taxable income from your current job will reduce the amount of income being taxed at 30 percent. For example, if you made $60k from dancing for a few months and $40k from your current position, then all of your income will be lumped together and you will be considered to have earned $100k for the year, and your tax rate will be based on having earned $100k. If you contributed $20k to a 401k, then your taxable income would be $80k and that is what your income tax rate would be based on. Hope this helps.
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
eagle2
I'm pretty sure you will be taxed on one lump sum for the year, so lowering your taxable income from your current job will reduce the amount of income being taxed at 30 percent. For example, if you made $60k from dancing for a few months and $40k from your current position, then all of your income will be lumped together and you will be considered to have earned $100k for the year, and your tax rate will be based on having earned $100k. If you contributed $20k to a 401k, then your taxable income would be $80k and that is what your income tax rate would be based on. Hope this helps.
But I will owe about 30% on the taxes from dancing (which came closer to $10k - I didn't work much), and my current employer is covering a portion of my current taxable income. So, wouldn't it be taxed separately? One is a 1099, the other is a W-4.
-
Re: Question about (legally) reducing taxable income
The W-4 is used for withholding taxes during the year. At the end of the year you will get a W-2 form from your employer. I'm pretty sure that at the beginning of next year, when you file your taxes, you will include both the income from your employer, and your income from being an independent contractor, and everything will be lumped together in calculating your tax rate. I've never worked as an independent contractor, so I'm not familiar with the related forms, but when I have multiple sources of income, such as dividends and interest income, all of my income from these sources along with my income as an employee are lumped together, and my tax rate is based on the total lump sum of all of these sources. I assume it works the same way with income made from being an independent contractor, but I don't know for sure, since I've never earned income this way.
-
Re: Question about (legally) reducing taxable income
Hi charlie61
The portion of you income earned while dancing is self employment income and subject to self employment tax of 15.3%. This income is reported on the schedule C of your form 1040. Any contribution to an IRA or 401(k) would not eliminate this tax, but the balance of 30% (30%-15.3% = 14.7%) tax you refer to on this income is regular income tax and can be reduced by pre-tax contributions to a 401(k). My suggestion is contact a CPA and discuss your specific situation to determine what courses of action are open to you.
-
Re: Question about (legally) reducing taxable income
Hi charlie61
The portion of you income earned while dancing is self employment income and subject to self employment tax of 15.3%. This income is reported on the schedule C of your form 1040. Any contribution to an IRA or 401(k) would not eliminate this tax, but the balance of 30% (30%-15.3% = 14.7%) tax you refer to on this income is regular income tax and can be reduced by pre-tax contributions to a 401(k). My suggestion is contact a CPA and discuss your specific situation to determine what courses of action are open to you.
-
Re: Question about (legally) reducing taxable income
Hi Charlie,
If you're filing single, you're most likely in the 25 percent ($37,650 to $91,150) or 28 percent ($91,150 to $190,150) tax bracket.
-
Re: Question about (legally) reducing taxable income
^ I'm filing jointly. My partner makes $110k. So, unfortunately, I'll be in a higher bracket.
-
Re: Question about (legally) reducing taxable income
If you're in a higher bracket, you're probably best off maxing out on your 401k to reduce your taxable income.
-
Re: Question about (legally) reducing taxable income
Charlie, at your income bracket, you cannot claim a tax deduction for contributing to an IRA if you also have an employer sponsored plan available to you. Below is a link to the limitations of the tax deductibility of contributions to IRAs for people who also have 401ks available.
https://www.irs.gov/retirement-plans...t-plan-at-work
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
rickdugan
Charlie, at your income bracket, you cannot claim a tax deduction for contributing to an IRA if you also have an employer sponsored plan available to you. Below is a link to the limitations of the tax deductibility of contributions to IRAs for people who also have 401ks available.
https://www.irs.gov/retirement-plans...t-plan-at-work
That is definitely helpful. So, by the looks of it, I should just max out my HSA, save what I would have put into the t-IRA to pay taxes, and continue using my work's 401k?
-
Re: Question about (legally) reducing taxable income
Also, what if I invest this money into the traditional IRA *BEFORE* I'm covered by my employer's 401k? My benefits don't start until July 1st. So, could I sneak that money in during June and then have no overlap between investing in my traditional IRA and my 401k?
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
That is definitely helpful. So, by the looks of it, I should just max out my HSA, save what I would have put into the t-IRA to pay taxes, and continue using my work's 401k?
That's how I would handle it, except that I would probably have my vanilla employer withhold extra from each paycheck and pay it to the tax authorities to help manage expected tax liabilities from the IC activities. It would let you smooth the payment process and alleviate the need to put the money aside elsewhere.
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
Also, what if I invest this money into the traditional IRA *BEFORE* I'm covered by my employer's 401k? My benefits don't start until July 1st. So, could I sneak that money in during June and then have no overlap between investing in my traditional IRA and my 401k?
I won't pretend to know all the ins and outs of the timing of split year issues, but I doubt that it would be worth the headache anyway. I typed up a long post on this before I saw your income post and deleted it, but long story short, you'd only be saving a few hundred bucks or so for the entire year even if you could. Your federal and state income taxes are the same regardless of whether you earn income from IC activities or employment, as are half of your SS taxes. So at best, you'd be able to save your self employment SS share on up to $5,500 (IRA contribution limit), so you'd be talking about $400 at most for the year even if you could max out your IRA. You wouldn't want to try that without talking to a tax pro to get a definitive answer, but even if you got the right answer his fee would eat up at least a piece of already nominal savings.
Anyway, perhaps somebody around here might have a more definitive answer, but that's my :twocents: for whatever it is actually worth.
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
rickdugan
I won't pretend to know all the ins and outs of the timing of split year issues, but I doubt that it would be worth the headache anyway. I typed up a long post on this before I saw your income post and deleted it, but long story short, you'd only be saving a few hundred bucks or so for the entire year even if you could. Your federal and state income taxes are the same regardless of whether you earn income from IC activities or employment, as are half of your SS taxes. So at best, you'd be able to save your self employment SS share on up to $5,500 (IRA contribution limit), so you'd be talking about $400 at most for the year even if you could max out your IRA. You wouldn't want to try that without talking to a tax pro to get a definitive answer, but even if you got the right answer his fee would eat up at least a piece of already nominal savings.
Anyway, perhaps somebody around here might have a more definitive answer, but that's my :twocents: for whatever it is actually worth.
Your advice is very helpful!
$400 in savings is worth it to me - I'm huge on saving money, even at the cost of a bit of a headache! I just wouldn't want to put $5,500 away into my (traditional) IRA if I won't even be able to keep it safe from taxes due to my having a 401k or because of my income bracket. Does that make sense?
It sounds like the HSA is a pretty safe bet. And it's sounding like if I put the money into my IRA, it could help a bit, too (though I could, as you suggested, keep that in the bank to help pay taxes this year). My stepfather was an accountant, so I'll be asking him to see if he has any advice.
Sometimes I wonder if being married is even worth it. We got married purely for tax purposes (at the time, I wasn't working, and we wanted to save by filing jointly). I would receive more benefits and breaks as an individual, since I make very little money right now (straight job with great benefits but fairly low starting pay).
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
Also, what if I invest this money into the traditional IRA *BEFORE* I'm covered by my employer's 401k? My benefits don't start until July 1st. So, could I sneak that money in during June and then have no overlap between investing in my traditional IRA and my 401k?
It doesn't matter when you start contributing to your 401k. There's a maximum dollar amount you can contribute, not a maximum percentage, as long as you don't exceed the maximum dollar amount. If you're less than 50 years old, the maximum amount is $18,000. If you're 50 or over, it's $24,000. If your benefits start July 1, and you want to maximized your contributions/deductions, just figure out the percentage of your income that comes out to $3,000 a month, and you'll end the year with $18,000 in contributions and deductions. If your monthly income before taxes is $5,000, you can contribute 60% to maximize your contributions/deductions.
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
Your advice is very helpful!
$400 in savings is worth it to me - I'm huge on saving money, even at the cost of a bit of a headache! I just wouldn't want to put $5,500 away into my (traditional) IRA if I won't even be able to keep it safe from taxes due to my having a 401k or because of my income bracket. Does that make sense?
It sounds like the HSA is a pretty safe bet. And it's sounding like if I put the money into my IRA, it could help a bit, too (though I could, as you suggested, keep that in the bank to help pay taxes this year). My stepfather was an accountant, so I'll be asking him to see if he has any advice.
Sometimes I wonder if being married is even worth it. We got married purely for tax purposes (at the time, I wasn't working, and we wanted to save by filing jointly). I would receive more benefits and breaks as an individual, since I make very little money right now (straight job with great benefits but fairly low starting pay).
I think that talking to your Dad is a good idea. There are a lot of things that we anonymous Internet types may not be thinking about or even know about your situation. You know that they say about free advice over the Internet... ;)
For example, you raised a good point that I really didn't think too much about to this point about being married and the impact that it likely has on every marginal dollar that you earn. For tax purposes, you and the hubby are one entity, so every dollar you earned as an IC comes with a higher marginal tax rate. So too does every dollar that you earn from your new plain vanilla job. You may need to make sure that your current vanilla employer is withholding enough for the bracket that you're in due to your husband's income. You and hubby could find yourselves facing a rather nasty tax bill if you don't get ahead of this. You may also need to explore whether it would be advisable to make an additional quarterly estimated tax payment, especially if you made a lot dancing.
Your father is certainly one option, but you may want to consider sitting down with an active tax accountant in order to sort this stuff out.
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
Also, what if I invest this money into the traditional IRA *BEFORE* I'm covered by my employer's 401k? My benefits don't start until July 1st. So, could I sneak that money in during June and then have no overlap between investing in my traditional IRA and my 401k?
For this year you may benefit from a traditional IRA, it depends on how much you actually make. But, for next year, if you continue with a 401K job, you should probably use a Roth IRA. Most likely next year you won't be able to deduct the traditional IRA contribution due to being covered by a 401K. You may not this year, you'll need to run the numbers. The income contributed to a Roth is not a reduction in your gross income for tax purposes, but the income and gains from the Roth are not included in income when you retire and start withdrawing them.
HTH
Z
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
Zofia
For this year you may benefit from a traditional IRA, it depends on how much you actually make. But, for next year, if you continue with a 401K job, you should probably use a Roth IRA. Most likely next year you won't be able to deduct the traditional IRA contribution due to being covered by a 401K. You may not this year, you'll need to run the numbers. The income contributed to a Roth is not a reduction in your gross income for tax purposes, but the income and gains from the Roth are not included in income when you retire and start withdrawing them.
HTH
Z
My employer only matches on traditional IRAs. So I have a Roth at 6% and a traditional at 6% (employer matches up to 6%).
So, do you know if my money will be safe from taxes in a traditional IRA, considering my household (spouse + me) income?
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
My employer only matches on traditional IRAs. So I have a Roth at 6% and a traditional at 6% (employer matches up to 6%).
So, do you know if my money will be safe from taxes in a traditional IRA, considering my household (spouse + me) income?
You've lost me there, Charlie./:O Did you mean to say that your employer only matches traditional 401K The "I" in IRA means an individual account outside the workplace. I'm surmising that a main concern of yours is the continued deductibility of a traditional IRA, and whether or not you could slide in under the wire during a transitional year in your life. Sorry, that question is outside my pay grade, best left to your father, or advisor.
I will try to weigh in on some other issues raised. If I'm correctly reading that employer matches 401K, I would seriously consider maxing out your 401K first, then put whatever is left over into whatever IRA you'd be qualified for. (I'm surmising that combined joint income might be too high for you to contribute to Roth IRA).
IMHO, one would be nuts NOT to take advantage of an employer 401K match.
As to whether your traditional IRA is "safe" from taxes: Yes it is, in that IRA accumulates earnings tax free. It is only when you withdraw from a traditional IRA that the amount of the withdraw is taxed as ordinary income. (Plus a penalty if done prior to age 59 1/2). Lastly, is the custodian for your company 401K a big one such as Fidelity, Vanguard ? If so, they probably have an office with advisors in a moderately large city near you. I'd set up an appointment with them for a more detailed discussion. HTH
-
Re: Question about (legally) reducing taxable income
^Yes! I meant a traditional 401k. Good catch!
-
Re: Question about (legally) reducing taxable income
Quote:
Originally Posted by
charlie61
My employer only matches on traditional IRAs. So I have a Roth at 6% and a traditional at 6% (employer matches up to 6%).
So, do you know if my money will be safe from taxes in a traditional IRA, considering my household (spouse + me) income?
While certain doomsayer posters think that traditional IRAs will be taxed away or means tested, there is no serious move to do that. As long as the government wants to avoid old age poverty, I can't see any set of circumstances that will really lead to some sort of means testing for traditional IRAs. What has happened, as it will either this tax year or next, you will have too much income to take advantage of the deduction for a traditional IRA and you will want to convert over to a Roth IRA. You can still keep your existing traditional IRA, but you will want to make future contributions to the Roth since they will be after tax dollars anyway. You might as well take advantage of the tax free growth provisions of a Roth.
HTH
Z