Tax Tips Blog

Jeffrey:
Hi, I have a question regarding being self employed and what taxes must be paid. I’ve been reading over the IRS documents regarding self-employment and the self-employment tax, however I was wondering if income tax must be paid on top of that tax. Basically, I would like to know what taxes must a individual pay if they made $2000 this year, and when must said taxes be paid. Thank you for your assistance and I look forward to hearing from you soon.

My reply:
Jeffrey,

Thanks for visiting my site and writing. Let me try to explain how the system works…

Based on your email it sounds like you’re a sole proprietor (you said your question related to self-employment taxes). Sole proprietors report their income on their Individual tax return. Individuals who owe self-employment tax, must add that tax to their total Federal income tax and if required make quarterly estimated tax payments of the combined amount.

If you happen to live in a state that collects individual taxes, then you’d owe that tax as well.

Before computing the amount based on $2,000 of contract income you’ll need to also have the answers to the following questions:

* filing status
* exemptions
* itemized deductions or standard deductions
* gain/loss on sale of stocks
* other income
* any adjustments from income other than social security tax
* contributions to retirement plans
* child tax credit
* is the $2,000 gross earnings or net earnings
* what state do you live in

there would be others, but I think you get the picture - you basically need to complete your tax return every quarter.

Best wishes,
Gina

Jay writes:
Hello Gina! I’m married and I file jointly with my wife. Our taxable income is about $45,000. I believe this means I can have capital gains of about $20K without paying taxes on these gains this year or next (assuming my income stays the same for 2009, which I believe it will).

Is there any reason I can’t sell stock my stock that has a gain and then turn around and buy the same stock at the same time and still not pay any capital gains tax and have an increase in the basis with the new stock I purchased?

Thanks,
Jay

My reply:
For 2008, since you will be filing MFJ, if your taxable income falls between $16,050 and $65,100, you will be in the 15% tax bracket. For 2008 through 2010, capital gains and certain qualified dividends will be taxed at 0% for taxpayers in this tax bracket.

This 0% rate would apply to your adjusted net capital gains. Your adjusted net capital gains includes any qualified dividend income (the dividends that are not treated as investment income) and your net long-term capital gains less your net short-term capital losses, not including any gains from the sale of collectibles, qualified small business stock and depreciable real property.

Based on the information that you provided to me, I cannot think of any reason why your plan would not be allowed; however I would run a tax projection to make sure that your large capital gains do trigger Alternative Minimum Tax (AMT).

Best wishes,
Gina

Steve writes:
I’m sure this question has been covered, but I can’t seem to find the answer I’m looking for….

My spouse does not work. I participate in a 401K. Our modified AGI likely will be 160+. As far as I can tell, we cannot contribute to a Roth IRA. I can contribute fully to a traditional IRA, and to a spousal IRA, up to a combined total of 8K. But no portion of any contribution that I make to either is deductible. Am I right thus far?

With this in mind, does it make sense to contribute to traditional/spousal IRAs, even though contributions are not deductible?

Thanks,
Steve

My reply:
Hello Steve! I have written a lot about retirement plans, including using a non-deductible IRA, and if those posts didn’t help you, I hope this one will…

First, your thinking is correct. Now to try to help you decide if contributing to a non-deductible IRA is right for you, please consider the following:

If you decide to make the non-deductible IRA contribution then you’re free to invest in whatever you like (that’s allowable for an IRA, of course) and you won’t have to worry about current taxes. You can change from one investment to another without incurring capital gains taxes. And when you do eventually withdraw the money from the IRA, you will recover your contributions tax free, so there is no double taxation. The taxable portion of the withdrawals will be taxed as ordinary income. So this would be a good place to invest in things that generate ordinary income anyway, such as corporate bonds, REITs and stock trading on a short-term basis.

And, if the law doesn’t change between now and 2010, starting in 2010, you’ll be able to convert your traditional IRAs to Roth IRAs, notwithstanding your income. You’ll pay tax (at ordinary income rates) on the appreciation between now and the time of conversion, of course, but from then on all further appreciation will be tax-free. If you already had substantial assets in a low-basis IRA, it probably wouldn’t make sense to consider this route, but it sounds like this will be your first traditional IRA.

Or, instead of contributing to a non-deductible IRA you could save for retirement outside of a retirement account, in an after tax account. The goal would be to try and take advantage of the current low tax rates on long-term capital gains and qualified dividends. To accomplish this you could purchase stocks that pay qualified dividends and plan on holding the stocks for at least a year. If you were able to accomplish this, then the maximum tax rate on these items would be 15%; thus you’ve limited your tax exposure. Another option would be to invest in tax-free bonds. With the possible exception of AMT, you would not pay taxes on the tax free bonds. Investments in real estate would be another option. Real estate investments can generate current tax free cash flow and long term gains.

There really isn’t a right or wrong way to go - it’s up to you and your preferences.

Best wishes,
Gina