Self-Employed Dilemma

Self-employed people often have a dilemma as far as estimating taxes are concerned. Most of the time, their income is not predictable and they are unsure of what their final income will be at the end of the year. This can present a challenge without professional help and advice.

Let us suppose we have a self-employed advertising executive that is hired by other firms to produce marketing plans. She expects her gross income to be $160,000. For the 2018 tax year, this puts her potentially in the 32% tax bracket before deductions. Some CPA's will say to just set aside 32% in a separate bank account and pay estimated taxes quarterly.

We can look at another alternative for argument sakes. Assume that our heroine is living in a state like Florida with no state income tax. She is using QuickBooks or Zoho Books and instead of paying herself a regular salary, she chooses to pay herself commission only. This would fit more with how her money comes in. It is unpredictable as to timing and amount, so the commission model would be best. We want her commission salary to be no more than the Social Security limit of $128,400. Otherwise, she would be paying extra and unnecessary FICA taxes. So, when her commission hits $128,400 she stops paying herself any more salary. You follow?

However, we want to add an Individual 401k to the mix, since she expects to gross $160,000 and easily meet her salary of $128,400. Based on this figure, she can contribute $32,100 to her i401k. $18,500 of it would be salary deduction and the balance, $13,600 would be a company match.

She has control over how to deposit these funds. For example, when she gets paid $6,000 in January for a project, then enter it in QuickBooks or Zoho Books as a commission. $18,500 divided by 12 equals $1,541.67. She puts $1,541.67 towards her i401k, then adds to that the company match which is $1,133.33 ($13,600 / 12). So, of that $6,000 commission, $2,675.00 went to her i401k and the balance was subject to taxes, FICA and Federal. Now, there is some additional cost to her which is the FICA paid by the employer. However, because she has this i401k, her Federal withholding will be significantly lower. FICA still gets paid regardless of the 401k, but you save in Federal withholding taxes.

Now let's review. She grossed $160,000, her commission salary was $128,400, but she was able to reduce that for Federal withholding down to a $97,300 taxable income. She has socked away $31,100 in her i401k. She has the difference between her gross commission of $160,000 minus the $128,400 commission salary to use for paying expenses and taxes.

Her tax bracket moves down from 32% to 24% assuming she is single saving her 8% as opposed to just paying estimated taxes based on the $160,000. Plus, she has a i401k with $32,100 in it after just one year! Imagine how this will quickly build a nice i401k.

If you need help with this kind of strategy, then let me know. You can reach me via email at rick@firstcoastplanning.com.