Caution if self-employeed, paying quarterly, and using TaxAct

[Jeremy Gibson]

On the recent poll regarding tax software I chimed in that I have used TaxAct for several years. My state program was just finished and I plugged all my numbers into the program last night. You can imagine my surprise when I ended up with a $10,000 bill to the IRS!! :eek: :eek:

Last year was my first full year as a self-employeed IT consultant. I get paid as a 1099 independent contractor from a long-term client. So, I used TaxAct at the end of 2005 to estimate my federal and state quarterly payments. Every month I would get my check from the client and first take out 30% to go into a "tax" savings account. Based on the estimate worksheet from TaxAct I was expecting to have put away a nice buffer in my account.:p

When I saw that I actually owed an additional $10K I went back to review the estimate worksheet for 2006 and the new one for 2007. I should have done this last year so I have myself to blame for that, but I saw that the TaxAct estimate worksheet miscalculated my self-employment tax by about $10K. :mad: (My next email is to TaxAct to get my $20 back and tell them of the error).

So - if you are self-employeed, pay quarterly tax estimates, and use TaxAct to help you calculate the payments...double or tripple check their calculations.

BTW, I have been redoing my return manually and so far have found no errors by TaxAct on the actual return. This only seems to be a problem with the quarterly tax estimate worksheet. That being said, I will not be using TaxAct anymore and will either switch to another program or, more likely, find a good CPA locally to help me setup a better solution for 2007.

[Joe Pelonio]

I hope they are willing to do more than just refund the purchase price.

I had a similar problem back in '93 where I owed the IRS $7,000 due to a miscalculation by an accountant. Since I hadn't paid for the service (friend!?!?!) I had no recourse. At the time, the IRS was willing to do a payment plan for it rather than paying all at once, don't know if they still do that.

Hopefully being your first year they will not charge you the penalties, since you had no full-year basis to determine the estimates.

[Jim DeLaney]

Jeremy,
What probably happened was that the software only calculated the income tax.

As a self-employed, you're also liable for both the employer and employee halves of Social Security and Medicare. The rate is (I think) 7.85% each - employer and employee - for a total of 15.7%. That'll probably account for the $10K that you owe.

One of the down sides of self employment. Of course, the recourse, if the local economy will stand for it, is to raise your consulting fees to compensate for your additional expenses. That, too, becomes a vicious circle, though, because when you raise your rates, IRS sees it as raised income, and taxes it accordingly...

[Jim Becker]

Do get with a CPA, even if you continue to do your own books and taxes so that you have a plan in place. It's worth paying for a little time for that piece of mind...

[Mitchell Andrus]

You can get around the 'self employment tax" - or most of it anyway... rent home office (or shop) space to yourself. The Rental Income is taxed so the same income tax is owed, but it's NOT taxed as 'self employment' income so the tacked on persentage doesn't happen.

Legit.

[Joe Mioux]

You can get around the 'self employment tax" - or most of it anyway... rent home office (or shop) space to yourself. The Rental Income is taxed so the same income tax is owed, but it's NOT taxed as 'self employment' income so the tacked on persentage doesn't happen.

Legit.

Be careful with this strategy.

The IRS will not allow you to pay yourself 100 or some unussually high rent for a building you own and a very small wage.

Also, don't you need to be incorporated for this strategy to work? You personally own the building and have to rent it to the corporation.

Joe

[Mitchell Andrus]

Right, you have to use common sence. You can't rent a space to yourself for too much more than the going rate, but you can then claim maintenance and a % of utilities, depreciation, etc. costs against the rental income.

The first time in 20 years of doing my own taxes (TurboTax) I went to an accountant to deal with capitol gains planning, and brought three years taxes. The very first thing he told me (after he put his disbelieving eyes back in his sockets) was to rent to myself as above and to file an amended return for the previous year. This is legal and saved me $6,500.00 that year.

No, you don't need to be incorporated. The IRS says that rent is a legitimate self employment cost, and rental income is legitimate too. You could easily rent to someone else and deduct the amount from your income, your landlord wouldn't pay 'self employment' income on this rental money, either. It's a wash for the government.

[Mitchell Andrus]

A little more...

From: http://www.smartmoney.com/tax/workbusiness/index.cfm?story=taxideas&adSection=smallbusiness&nav=smallbusiness


Hire the Kids
If you operate a sole proprietorship or husband-wife partnership, think about hiring your children under the age of 18. It can cut the tax bite on family income. Why? Because you get a business deduction for money you may have just given the kids anyway. That deduction reduces both your income and self-employment tax. On the kid side of the deal, there are no Social Security or federal unemployment taxes, and each child can shelter up to $5,350 of wage income (in 2007) with his or her own standard deduction. So you get a tax break, and there's zero tax cost to your children with this perfectly legal scheme. If this idea seems worthwhile, don't abuse it. Wages paid to your children must be reasonable in relation to the job. Paying $20 an hour to a seven-year-old to sweep the floors just won't fly with IRS auditors.

So... buy your 17 year old kid a $3,000.00 car. The car isn't deductable, but the $3,000.00 in wages paid to him are. More off self employment taxes.

Google: "self employment tax deductions" - use the quotes.

[Jim Becker]

There is a downside to the rental strategy when it comes to selling your home in the future. Be sure that the CPA goes over ALL of the scenarios with you so you understand both current and future ramifications. Even those of us who take a "home office" deduction have to be careful with this relative to future implications.