Tax Strategy for 1099 Income

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creditdefaultswaps
Posts: 31
Joined: Mon Jan 02, 2017 7:56 pm

Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sat Jun 17, 2017 10:35 pm

I have a W2 gig where I make around $180K/yr and I recently landed a consulting gig that is netting me an additional $7500 per month in 1099 income. Because of the nature of my consulting, my expenses are next to nothing.

How much should I be prepared to spend in taxes on the $7500/month (it's safe to assume the gig will last through the year at least)? Are there any other strategies could I employ to minimize my tax bill?

avalpert
Posts: 5148
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Re: Tax Strategy for 1099 Income

Postby avalpert » Sat Jun 17, 2017 11:50 pm

You should set up a Solo 401k - that will let you put away ~20% pre-tax. Be diligent about tracking genuine expenses/deductions that you might miss (such as tracking miles if you have to drive to meet the client and keeping an appropriate log).

Other than that, expect to pay your marginal income tax rate + medicare employee/employer rate of 2.9%. Because of your W2 income you should have any social security taxes. Be sure to make estimated payments by quarter due dates to avoid an underpayment penalty.

creditdefaultswaps
Posts: 31
Joined: Mon Jan 02, 2017 7:56 pm

Re: Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sun Jun 18, 2017 12:01 am

avalpert wrote:You should set up a Solo 401k - that will let you put away ~20% pre-tax. Be diligent about tracking genuine expenses/deductions that you might miss (such as tracking miles if you have to drive to meet the client and keeping an appropriate log).

Other than that, expect to pay your marginal income tax rate + medicare employee/employer rate of 2.9%. Because of your W2 income you should have any social security taxes. Be sure to make estimated payments by quarter due dates to avoid an underpayment penalty.


I'm already contributing to my W2 employer's 401K. Should I still open a solo 401K or can I contribute to the one I currently have?

Re: making estimated tax payments. I've just invoiced my second month, meaning I will have earned $15K by the end of this month. If I have to make quarterly estimated tax payments, I just missed the June 15th deadline. Will I penalized?

If my marginal tax rate is 33% and you are suggesting I also add 2.9%, then I should be socking away 35.9% of ($7500 - 20% for 401K) each invoice towards taxes?

avalpert
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Joined: Sat Mar 22, 2008 4:58 pm

Re: Tax Strategy for 1099 Income

Postby avalpert » Sun Jun 18, 2017 12:41 am

creditdefaultswaps wrote:
avalpert wrote:You should set up a Solo 401k - that will let you put away ~20% pre-tax. Be diligent about tracking genuine expenses/deductions that you might miss (such as tracking miles if you have to drive to meet the client and keeping an appropriate log).

Other than that, expect to pay your marginal income tax rate + medicare employee/employer rate of 2.9%. Because of your W2 income you should have any social security taxes. Be sure to make estimated payments by quarter due dates to avoid an underpayment penalty.


I'm already contributing to my W2 employer's 401K. Should I still open a solo 401K or can I contribute to the one I currently have?

Yes, while you can only contribute $18k as an employee across both plans, you can contribute as an employer to your Solo 401k plan, 20% of adjusted net income up to $54k.

Re: making estimated tax payments. I've just invoiced my second month, meaning I will have earned $15K by the end of this month. If I have to make quarterly estimated tax payments, I just missed the June 15th deadline. Will I penalized?

For this year, you should make sure your W2 withholdings equal 110% of last years total taxes due - that is a safe harbor that will prevent any penalties (I believe).

If my marginal tax rate is 33% and you are suggesting I also add 2.9%, then I should be socking away 35.9% of ($7500 - 20% for 401K) each invoice towards taxes?

Correct - the 2.9% will be calculated on Schedule SE of Form 1040.

Phil DeMuth
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Re: Tax Strategy for 1099 Income

Postby Phil DeMuth » Sun Jun 18, 2017 12:01 pm

Open your own defined benefit plan. You have to hire an actuary but these plans are surprisingly flexible and you can shelter as much money from your side gig as you want. They can be used on top of your other retirement plans.

creditdefaultswaps
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Re: Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sun Jun 18, 2017 12:22 pm

Yes, while you can only contribute $18k as an employee across both plans, you can contribute as an employer to your Solo 401k plan, 20% of adjusted net income up to $54k.


My W2's 401K does matching. Does the 18K include the matched funds or only the funds I personally contribute, even if it means with matching I will exceed the $18K?

As for the Solo 401K, how do contributions get attributed to the "employer" if I'm a sole-proprietor? When I make a transfer, does the platform ask who is making the contribution (employee vs. employer) or is this something my CPA will attribute correctly when she does my taxes?

Any recommendations for a Solo 401K broker? Vanguard?

Thanks again for your help!

avalpert
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Re: Tax Strategy for 1099 Income

Postby avalpert » Sun Jun 18, 2017 12:31 pm

creditdefaultswaps wrote:
Yes, while you can only contribute $18k as an employee across both plans, you can contribute as an employer to your Solo 401k plan, 20% of adjusted net income up to $54k.


My W2's 401K does matching. Does the 18K include the matched funds or only the funds I personally contribute, even if it means with matching I will exceed the $18K?

The $18k does not include any employer matching - those are just employee contributions.

As for the Solo 401K, how do contributions get attributed to the "employer" if I'm a sole-proprietor? When I make a transfer, does the platform ask who is making the contribution (employee vs. employer) or is this something my CPA will attribute correctly when she does my taxes?

I don't know whether the platforms ask or not - I manage mine myself - but the contributions are all recorded on your 1040 (line 28 I believe) so your CPA (or you) will attribute it correctly on your taxes.

Any recommendations for a Solo 401K broker? Vanguard?

It will depend on your needs (would you rollover a IRA or 401k, want a Roth today or in the future, etc.) The most commonly discussed are Vanguard, Fidelity and TD Ameritrade. All should have no fees, have access to good fund choices with no transaction costs (I believe Vanguard is only investor shares though), etc.
I personally use TD Ameritrade tax-exempt trust accounts as the brokerage for my 401k plan but I do not use their 'Solo 401k service'.

randomguy
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Re: Tax Strategy for 1099 Income

Postby randomguy » Sun Jun 18, 2017 12:36 pm

Phil DeMuth wrote:Open your own defined benefit plan. You have to hire an actuary but these plans are surprisingly flexible and you can shelter as much money from your side gig as you want. They can be used on top of your other retirement plans.


Evey DBP has that I have seen has contribution limits. With only ~90k (and without knowning the age of the OP), I would be worried that the costs (couple thousand/year in most cases) would eat up any potential savings. It also limits the amount you can contribute to a 401(k)/SEP-IRA. You would have to run the math.

Fidelity is a better solo 401(k) broker in my experience. They have cheaper index funds, better customer service, and let you do roll overs. You could probably also do a sep-ira if you are not doing backdoor roths. If you can't do employee contributions, you end up with the same amount of money but less paperwork.

creditdefaultswaps
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Re: Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sun Jun 18, 2017 5:08 pm

I just spoke with Fidelity and they proposed I look at a SEP IRA vs Solo 401K. If I'm only planning to earn a maximum of $75K / yr in 1099 income, is there any effective advantage of the 401K over the SEP IRA? Also, can my spouse (who is purely 1099) also contribute to either of these?

avalpert
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Re: Tax Strategy for 1099 Income

Postby avalpert » Sun Jun 18, 2017 5:20 pm

creditdefaultswaps wrote:I just spoke with Fidelity and they proposed I look at a SEP IRA vs Solo 401K. If I'm only planning to earn a maximum of $75K / yr in 1099 income, is there any effective advantage of the 401K over the SEP IRA? Also, can my spouse (who is purely 1099) also contribute to either of these?

Do you do backdoor Roth IRA contributions or would you like to?

Your spouse can set up her own Solo 401k, contribute $18k as employee and 20% of net-income as employer up to $54k in total.

creditdefaultswaps
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Re: Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sun Jun 18, 2017 5:24 pm

Do you do backdoor Roth IRA contributions or would you like to?


I have no idea. That's not a subject I'm all that familiar with. I currently have about 100K in a Traditional IRA if that helps. I believe I chose not to open an Roth because I think I make too much money.

Your spouse can set up her own Solo 401k, contribute $18k as employee and 20% of net-income as employer up to $54k in total.

So I understand correctly, if my spouse makes $60K/year, they would be able to contribute $18K + [20% of (60K-18K) up to $54K]? I suppose the same question applies, could/should we use a SEP IRA here too?

avalpert
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Re: Tax Strategy for 1099 Income

Postby avalpert » Sun Jun 18, 2017 5:41 pm

creditdefaultswaps wrote:
Do you do backdoor Roth IRA contributions or would you like to?


I have no idea. That's not a subject I'm all that familiar with. I currently have about 100K in a Traditional IRA if that helps. I believe I chose not to open an Roth because I think I make too much money.


With the Solo 401k, you could roll your existing Traditional IRA into it and then be able to make after-tax IRA contributions that you convert to Roth - in essence making Roth contributions every year. With a SEP-IRA you won't be able to do that without creating a significant tax liability.

Your spouse can set up her own Solo 401k, contribute $18k as employee and 20% of net-income as employer up to $54k in total.

So I understand correctly, if my spouse makes $60K/year, they would be able to contribute $18K + [20% of (60K-18K) up to $54K]? I suppose the same question applies, could/should we use a SEP IRA here too?

In her case she will almost certainly be better off with the Solo 401k because the SEP doesn't allow you to make the $18k employee contribution - so you can contribute more with less income into the Solo 401k.

creditdefaultswaps
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Re: Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sun Jun 18, 2017 5:54 pm

With the Solo 401k, you could roll your existing Traditional IRA into it and then be able to make after-tax IRA contributions that you convert to Roth - in essence making Roth contributions every year. With a SEP-IRA you won't be able to do that without creating a significant tax liability.


I'm almost with you here. Let me see if I understand. I could open the Solo 401K and roll my traditional IRA into it, leaving me with just my Solo 401K, my employee-sponsored 401K and my other taxable accounts. I lose you on "make after-tax IRA contributions that you convert to Roth - in essence making Roth contributions every year".

How am I making after-tax IRA contributions if I rolled over my IRA and my contributions to the solo 401K are pre-tax up to the allowable limits? I'm getting the gain of paying less taxes now since my basis is lowered by contributions to the solo 401K, but what about when I reach retirement? Will I pay taxes on distributions from this 401K?

Also, this contracting gig will end in a year. After the 1099 goes away, will I be left with any negative repercussions of having moved my biggest nest eggs to the Solo 401K?

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BL
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Re: Tax Strategy for 1099 Income

Postby BL » Sun Jun 18, 2017 6:07 pm

Here is Wiki page on Backdoor Roth:
https://www.bogleheads.org/wiki/Backdoor_Roth_IRA

This can be done if you have no non-Roth IRAs. This may be a big advantage to setting up a 401k retirement account. You can contribute to Roth IRA even at a high income.

Your spouse can do it if no non-Roth IRAs in his/her name.
Last edited by BL on Sun Jun 18, 2017 6:12 pm, edited 2 times in total.

Spirit Rider
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Re: Tax Strategy for 1099 Income

Postby Spirit Rider » Sun Jun 18, 2017 6:09 pm

creditdefaultswaps wrote:
Your spouse can set up her own Solo 401k, contribute $18k as employee and 20% of net-income as employer up to $54k in total.

So I understand correctly, if my spouse makes $60K/year, they would be able to contribute $18K + [20% of (60K-18K) up to $54K]? I suppose the same question applies, could/should we use a SEP IRA here too?

The amount of one-participant 401k retirement plan contributions is based off of net self-employment income = net business profit - 1/2 SE tax.

The maximum employer contribution is calculated as 20% of net self-employment income. The employee deferral does not reduce the basis for this calculation. If the net self-employment income (not net business profit) is $60K, the maximum calculated employer contribution would be $60K * 0.20 = $12K.

Therefore, the maximum one-participant 401k contributions would be $18K employee deferral + $12K employer contribution = $30K. Since this is < $54, it will not be further limited.
Last edited by Spirit Rider on Sun Jun 18, 2017 6:16 pm, edited 1 time in total.

monsterid
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Re: Tax Strategy for 1099 Income

Postby monsterid » Sun Jun 18, 2017 6:13 pm

I am in the EXACT situation you are with W2 income + 1099 income. I do this:

- Max 18k into W2 401k
- Get any W2 401k match
- Contribute 20% of net profit from schedule C to individual 401k pre-tax account
- Contribute up to $54k (less all previous contributions above) to individual 401k after tax non-roth account and roll to Roth IRA (i.e. a "mega backdoor roth")
- do a backdoor roth IRA by taking $5,500 into a tIRA and then rolling it to a rIRA (assume you don't have any other tIRAs i.e. 0 prior balance)

I can do this because I have setup my own 401k rather than use off the shelf ones from Vanguard etc. PM if you need help on this, cost me $800. After I also do a HSA I'm at c. $63k in yearly tax advantages account contributions... game changer.

rrppve
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Re: Tax Strategy for 1099 Income

Postby rrppve » Sun Jun 18, 2017 6:15 pm

You should really look at finding a way to have some business expenses against both your and your spouses 1099 income. Computers, telecom, travel & entertainment, etc. Using some of the income to cover expenses makes it 0%.
I wouldn't bother rolling the tIRA into the solo 401(k), at least at this point. There are a couple of issues with defining when you have a separation in service with a solo 401(k) that may affect your access to the money pre-retirement that don't exist with a tIRA. The only advantage of the rollover is simplifying by one account unless it is a part of a backdoor Roth IRA strategy where you isolate your pretax in the solo 401(k).

avalpert
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Re: Tax Strategy for 1099 Income

Postby avalpert » Sun Jun 18, 2017 6:22 pm

creditdefaultswaps wrote:I lose you on "make after-tax IRA contributions that you convert to Roth - in essence making Roth contributions every year".

How am I making after-tax IRA contributions if I rolled over my IRA and my contributions to the solo 401K are pre-tax up to the allowable limits?

You make after-tax contributions into a new Traditional IRA (they aren't deductible because your income is too high). You can then convert them to a Roth IRA, since they are after-tax contributions that doesn't create any additional taxes. Do a search on the forum or the wiki for 'Backdoor Roth'.

I'm getting the gain of paying less taxes now since my basis is lowered by contributions to the solo 401K, but what about when I reach retirement? Will I pay taxes on distributions from this 401K?

Yes, you will pay taxes on distribution or if/when you convert them to a Roth. Given your high income, you are most likely in a higher tax bracket now then you will be when you withdraw or convert. If you retire early before social security you may even have a few years where you can convert your 401k to Roth IRAs in lower tax brackets.

Also, this contracting gig will end in a year. After the 1099 goes away, will I be left with any negative repercussions of having moved my biggest nest eggs to the Solo 401K?

You will no longer be able to make new contributions. The worst case scenario beyond that is that you close the 401k and roll the funds back into an IRA - but you don't need to do that until you determine you have no intention of seeking future 1099 possibilities.

creditdefaultswaps
Posts: 31
Joined: Mon Jan 02, 2017 7:56 pm

Re: Tax Strategy for 1099 Income

Postby creditdefaultswaps » Sun Jun 25, 2017 12:04 am

I wanted to post a quick update since my Solo 401(k) is now open with Fidelity. Thank you all, especially @avalpert, for your guidance thus far.

Here's how I'm planning to save the 60K I'm forecasted to earn in 1099 income this year:

* 20% towards Solo(401k) in a Bogleheads Three-Fund portfolio consisting of:
  • iShares Core S&P Total Market ETF (ITOT) 64%
  • iShares Core MSCI Total International Stock ETF (IXUS) 20%
  • iShares Core Total U.S. Bond Market ETF (AGG) 16%
* 30% of Remainder for Taxes
* 35% of Remainder in Taxable Account (Betterment)
* 35% of Remainder in Interest-bearing Savings Account

How's that sound?


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