How to Reduce Your Taxable Income

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Last week I received an email from a fellow blogger (we’ll call him Blogger X) letting me know that he was going to file his taxes soon, and he asked if I could offer him any last minute suggestions?

I responded to his email and offered a few pieces of advice, along with a few alternatives that I thought he could explore further. (It’s worth noting, I believe 2007 was the first year Blogger X earned an income from his blog.)

A mild disclaimer

I plan on detailing the gist of what I wrote to him in this post, but before I do, I want to say in big letters I AM NOT A CPA and before making any tax related decisions please consult your accountant and do your own due diligence.

With that said, and at the risk of sounding redundant, here’s an excerpt from my email response to Blogger X…

… because of the uniqueness of this year for you, where all of a sudden you have this new and growing stream of income, it might be worth it for you to invest in one [a CPA], at least for one year… to set you straight going forward (create schedules, etc.)…

Self employed taxable income

Although I’m using Blogger X as an example, the content in this post applies to most bloggers, many of which are starting (or continuing) to earn income from their blogs. If you’re self employed or earning income on the side (and you’re not a blogger), all of this information applies to you, as well.

If you have a part time business and earn more than $400 in net earned income the IRS requires you to pay self employment tax by filing a Schedule SE, attached to your Form 1040 - US Individual Income Tax Return. Along with this wonderful new responsibility come a few strings attached, some positive and some negative.

Drawbacks of generating self employment income:

• You have to pay income taxes on your earnings. Although this could be looked at as a positive, as I sometimes tell clients, … “you’re earning more money!”
• You have to file Schedule SE and pay self-employment tax, which covers your contributions to Social Security and Medicare, same as the amounts withheld from the paychecks of most wage earners. Except in this case, you are both the employer and employee, so you pay double, yikes. At the same time, you get to deduct half of your SE tax from your total income. (Click the above link to learn more on self employment tax and rates.)
• Much of the tax you owe will come in the form of estimated tax payments. Since you are self employed, you need to set up a schedule of estimated tax payments for yourself, which will be done on a quarterly basis.

Positives associated with Blogger X’s new found self employment income:

• Since Blogger X’s income can be classified as self-employment income, all the perks of being self employed come with that.
• There are many deductions Blogger X can now take, including computer costs, subscriptions, hosting, supplies, portions of the rent, etc. This is where a good CPA earns his (or her) keep (at least for one year); giving you a really good idea of how much of your costs are truly deductible.
• Being self employed qualifies Blogger X as an EMPLOYER. As an employer you can set up all kinds of cool EMPLOYER sponsored retirement plans.
• With the ability to setup all kinds of cool retirement plans, Blogger X can sock away a lot more money than the normal wage earner, and most importantly, shelter it from being included in his taxable income.
• Here are some of the cool employer sponsored plans Blogger X can setup:
  1. a SEP plan (simplified employee pension)
  2. a SIMPLE IRA (savings incentive match plan for employees)
  3. a KEOGH Plan
  4. and a Solo 401(k) plan.
• This is where it gets really cool! In 3 of the 4 plans mentioned, Blogger X could put away up to $46,000 pre-tax for 2008. (Check with your CPA for proper integration with any pre-existing plans you may have) Last week I illustrated a very real example of a self employed business owner, earning $120,000 a year, who was able to contribute the maximum to his 401k.
• This could very much become a reality for some bloggers I know. In fact, I would be surprised if a guy like JD from GRS doesn’t have something like this setup already, especially since he just visited his accountant and lawyer.
• With all these new options, which to choose? Well, I will dedicate a post to each of the 4 plans over the next few days, detailing the pros and cons of each. I will also discuss how each plan integrates with any pre-existing employer sponsored plans or IRA’s you may have.

What of Blogger X?

In case you were wondering, after our conversation Blogger X spoke with his accountant and they immediately setup a SEP. He made a 2007 contribution which will serve to reduce his reportable income. I’m going to assume his accountant also gave him some good ideas on further reducing his reportable income, via deductions.

If you’re a blogger (making some extra coin) I’d love to have you weigh in and share some of your thoughts on the topic?

• This post was proudly featured, under the Terry Fox category, in the 143rd Carnival of Personal Finance over on Quest for Four Pillars.

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