tax strategy for side income

[J_Markov]

I recently started making some extra income on the side as an IC and I'm trying to figure out the best strategy going forward when it comes to taxes. My current situation is that I'm a full-time employee making most of my income, by far, as W2. I've been maximizing 401k and doing backdoor roth. I recently started doing some consulting job on the side, and predict I'll probably make a few thousand dollars a year this way, which will probably be about 1% of my total annual income. This may grow in the future, but at least for this year it will probably stay like this.

My questions are:
-Should I start a company for the 1099 income? This way I can probably claim expenses starting the company, etc... (?)
-Should I set up a SEP IRA vs individual 401k?

Would appreciate any other advice.

[livesoft]

Your side income will be reported on Schedule C on which you can claim expenses whether you start a company or not. A "sole proprietorship" is not a company.

You should start reading the IRS publications for small businesses which you now have. See irs.gov/publications/

Since this is such a small part of your income, I don't think you need to start a self-employed retirement plan right now. You can re-think that in December 2017. The reason is that you contribute max to your W-2 job 401(k) of $18K or $24K anyways. This means a solo 401(k) can only accept your "employer" contribution which will be something under 25% of your 1099-MISC income or probably less than $1,000 a year. I found that not worth it. However, if you can contribute nearly 100% to a self-employed plan, then it is worth it. That might happen if you quit your W-2 job.

[EATaxGuy]

It doesn't matter too much right now. You have started a company (more or less), all it is missing is a name. You are a sole-proprietor.
Your sole-proprietorship is what is known as a pass-through entity. You will claim your income and expenses on Schedule C and they will pass through to your form 1040 individual income tax return.

You can establish an LLC for some liability protection. You will still claim income and expenses on Schedule C UNLESS you opt to be taxed as a corporation with a sub-chapter S designation. Then you will claim income and expenses on form 1120, issue yourself a K-1, and your income and expenses STILL pass through to your 1040 individual income tax return.

If you become wildly successful with your side gig you make want to look at a Solo 401K. You can hammer some serious money into that if you make enough. For now, though, I'd stay with the company plan.

Best of Luck with Your Endeavor!

[Gill]

A "sole proprietorship" is not a company.

It's not a corporation but it can certainly fall within the definition of a company.
Gill

[Phil DeMuth]

If you don't need the money for living expenses, after putting the max in your qualified plan of choice, you could put the rest in a defined benefit plan. These are far more flexible that usually thought. The key is to find a low-fee actuary.

[tj]

You could deduct up to an extra 10k or so with a simple ira, but not if you want to do backdoor roth.

[J_Markov]

Thank you, everyone, for the advice.

It seems that for now there's not much advantage in doing anything specific regarding tax deferred contributions. I will probably just try to maximize every other possible tax deduction that comes with earning 1099 money (car expenses, meals, travel, etc...).

[J_Markov]

Hi everyone,

Just wanted to update on what has happened with my side job. It actually turned out to be much more lucrative than what I thought as I obtained some unexpected contracts. My income on my personal side business will be in the mid to high 5 figures. So I'm going to ask the same questions again: how should I maximize my tax deferred money with the 1099 income? To remind you, I already maximized my 401k with my W2 job and did a backdoor Roth at the beginning of the year. Would appreciate any advice. Thank you.

[itstoomuch]

Congratulations.
See a CPA.
Our son (32) uses his extra income (Airbnb) for Discretionary uses: Inviting parents (mom & dad) on small trips; Home improvement; Discretionsrary stock and ETF monthly dollar-cost-averaging purchases, and hopefully something for a future wife and children His current capital gain and dividend tax rate is less than his expected future (~30+ years) retirement tax rate.
Ymmv

[avalpert]

I recently started making some extra income on the side as an IC and I'm trying to figure out the best strategy going forward when it comes to taxes. My current situation is that I'm a full-time employee making most of my income, by far, as W2. I've been maximizing 401k and doing backdoor roth. I recently started doing some consulting job on the side, and predict I'll probably make a few thousand dollars a year this way, which will probably be about 1% of my total annual income. This may grow in the future, but at least for this year it will probably stay like this.

My questions are:
-Should I start a company for the 1099 income? This way I can probably claim expenses starting the company, etc... (?)

From a tax perspective you have already set up a company for the 1099 income - you are a sole proprietor. You can claim legitimate expenses exactly the same as if you were anything else.

-Should I set up a SEP IRA vs individual 401k?

If you already putting $18k in a 401k through your W2 job it might not matter much. Other considerations are having no pre-tax IRA money if you do backdoor Roth considerations. In either case you will be able to put away 20% of net income (adjusted for the employer portion of self employment tax which will depend on how much social security earnings you get on your W2) pre-tax as employer contributions.

[avalpert]

Your side income will be reported on Schedule C on which you can claim expenses whether you start a company or not. A "sole proprietorship" is not a company.

You should start reading the IRS publications for small businesses which you now have. See irs.gov/publications/

Since this is such a small part of your income, I don't think you need to start a self-employed retirement plan right now. You can re-think that in December 2017. The reason is that you contribute max to your W-2 job 401(k) of $18K or $24K anyways. This means a solo 401(k) can only accept your "employer" contribution which will be something under 25% of your 1099-MISC income or probably less than $1,000 a year. I found that not worth it. However, if you can contribute nearly 100% to a self-employed plan, then it is worth it. That might happen if you quit your W-2 job.

I find it amusing that someone who bunches deduction and aggressively tax lost harvest while maintaining plenty of accounts thinks an easy $1000 in additional pre-tax savings isn't worth it.

I guess everyone prioritizes in their own way.

[avalpert]

Hi everyone,

Just wanted to update on what has happened with my side job. It actually turned out to be much more lucrative than what I thought as I obtained some unexpected contracts. My income on my personal side business will be in the mid to high 5 figures. So I'm going to ask the same questions again: how should I maximize my tax deferred money with the 1099 income? To remind you, I already maximized my 401k with my W2 job and did a backdoor Roth at the beginning of the year. Would appreciate any advice. Thank you.

In that case open a Solo-401k (do it now so you get it done before end of year) and you can put in 20% adjusted net income as an employer match.

[J_Markov]

In that case open a Solo-401k (do it now so you get it done before end of year) and you can put in 20% adjusted net income as an employer match.

I actually registered an LLC (S-corp). Does that mean I can put aside 25% of gross income I get as 1099?

[avalpert]

In that case open a Solo-401k (do it now so you get it done before end of year) and you can put in 20% adjusted net income as an employer match.

I actually registered an LLC (S-corp). Does that mean I can put aside 25% of gross income I get as 1099?

With an S-Corp you can put aside 25% of the W2 income you pay yourself provided there is enough earnings left in the LLC after paying the W2 and employer payroll taxes to cover it.

But why would you elect to be taxed as an S-Corp? As an S-Corp you have to pay the employer portion of social security even if your income as an employee is above the cap between your two W2 jobs - which actually means increased tax burden relative to a sole proprietor who doesn't have to pay the additional employer payroll taxes if their combined income is above the cap.

[J_Markov]

But why would you elect to be taxed as an S-Corp? As an S-Corp you have to pay the employer portion of social security even if your income as an employee is above the cap between your two W2 jobs - which actually means increased tax burden relative to a sole proprietor who doesn't have to pay the additional employer payroll taxes if their combined income is above the cap.

One of my clients required me to sign a contract with them as a company, not as an individual, that's why I did an LLC.

[avalpert]

But why would you elect to be taxed as an S-Corp? As an S-Corp you have to pay the employer portion of social security even if your income as an employee is above the cap between your two W2 jobs - which actually means increased tax burden relative to a sole proprietor who doesn't have to pay the additional employer payroll taxes if their combined income is above the cap.

One of my clients required me to sign a contract with them as a company, not as an individual, that's why I did an LLC.

That's fine, but you can be an LLC and still be taxed as a sole proprietor - in fact that is the default tax method for an LLC. You have to actively elect to be taxed as a Corporation (filing form 8832 with the IRS), and separately elect to be taxed as an S-Corp (filing form 2553).