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Shane-CPA
Shane-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 265
Experience:  Shane Northrop is a Certified Public Accountant, Personal Financial Specialist and a Chartered Global Management Accountant
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I have worked as an independent contractor this year, I think

Resolved Question:

I have worked as an independent contractor this year, I think I will be making close to 100k to 120k this year and will be paying taxes at the end of year
where do I invest so I end up paying less taxes, some have advised SEP IRA
I am not sure what to do, kindly advise
Submitted: 1 year ago.
Category: Tax
Expert:  Shane-CPA replied 1 year ago.

Shane-CPA :

Hello...my name is XXXXX XXXXX I am a Certified Public Accountant. I look forward to assisting you with your questions.

Shane-CPA :

As an independent contractor, I am assuming you have no employees. The reason I ask is because some retirement plan choices must take employees into account.

Customer:

yes I donot have any employees

Shane-CPA :

SEP IRAs work in almost the exact same way as a traditional IRA. The only really important difference is the contribution limit. For 2012, if you have a SEP, you are allowed to contribute the lesser of:



  1. 25% of your net earnings from self-employment, or

  2. $50,000

Customer:

what should I do inorder to pay less taxes or NO taxes?

Shane-CPA :

One important thing to note is that, for purposes of calculating your maximum contribution, “net earnings from self-employment” is perhaps not quite what you’d expect. Basically, it’s all your revenues, minus your expenses but also minus two other items:



  1. The deduction for one-half of your self-employment tax, and

  2. The deduction for contributions to your SEP IRA.

Shane-CPA :

I'm comparing the plans to see what will provide you the greatest benefit...

Customer:

thanks

Shane-CPA :

An individual 401(k) plan functions very much like a 401(k) plan with a person’s employer. The difference is that you are allowed to make a contribution in the role of employee and a contribution in the role of employer. You are allowed to make:



  1. An employee contribution of 100% of your net earnings from self-employment, up to $17,000 for 2012 ($22,500 if you are 50 or over), plus

  2. An employer contribution of 25% of your net earnings from self-employment.


Note that this employer contribution is the same as the contribution you can make to a SEP IRA. As with a SEP IRA, 25% of net earnings from self-employment works out to 20% of your net earnings from self-employment before considering your deduction for retirement plan contributions.


Also, the total contribution is limited to the lesser of your net earnings from self-employment or (for 2012) $50,000.

Customer:

i am sorry i didnot understand what you said about deductions

Shane-CPA :

The deduction part is a little tricky...this helps you determine the maximum you can contribute to either account. It basically works out to being 20% of your net earnings from self-employment before considering your deduction for retirement plan contributions.

Customer:

kindly talk to me as you are talking to a 6yr/10yr old

Customer:

where would you put your money?

Shane-CPA :

of course...sorry for any confusion...the tax code can sometimes word things in a difficult manner...

Customer:

where would you put your money so that you don't have to pay taxes or may be get some back from IRS?

Customer:

sorry from my side too..

Shane-CPA :

The Individual 401(k) might be a better option because you could most likely contribute more to it than a SEP IRA (although it might be close). For 2012 you can contribute $17,000 plus (20% of the $100,000 or $120,000 self-employment income). This would be roughly $37,000.

Shane-CPA :

The SEP IRA in this instance would be limited to a contribution of roughly $20,000 to $24,000 (20% of $100,000 vs. 20% of $120,000)

Shane-CPA :

However, this will only help minimize your tax liability. You will still owe taxes based upon self-employment tax as an independent contractor and federal taxes.

Shane-CPA :

Have you made estimated tax payments for 2012?

Customer:

I am not a tax person but it will be based on 100k to 120k

Customer:

sorry for delay the internet slowed down

Customer:

i have 3 dependents ...my wife and 2 children

Shane-CPA :

no problem...okay...i would recommend making an estimated tax payment to the IRS before year-end.

Shane-CPA :

As an independent contractor, none of the income you are receiving has had tax paid on it.

Customer:

is there anything other than SEP or 401k where I can put my money?

Customer:

yes i have not paid any taxes yet

Shane-CPA :

Well there are other options, but most of them will not provide you with a tax deduction, if that is what your goal is

Shane-CPA :

Do you have business expenses?

Customer:

yes I use my cell, buy clothes, have one room which i use as an office

Customer:

i am not sure about anything else as it is not coming to my mind

Shane-CPA :

okay...that will help but it won't substantially reduce the $100k - $120k of self-employment income

Shane-CPA :

Self-employment tax alone on $100,000 is roughly $13,300 for 2012.

Customer:

so if put 20,000 in SEP or 401k how much taxes will i have to pay?

Customer:

lets say if I want to contribute 20,000 for next 3 years after which i start contributing 40,000...which one should i pick SEP or 401k?

Shane-CPA :

Well you may not be able to contribute $40,000. It would depend upon the income limitations. However, based on the scenario you have provided, I think the Individual 401k would allow you to contribute more each year than the SEP IRA.

Shane-CPA :

For example, the maximum you could contribute in 2012 under the 401k is $37,000 if your self-employment income is $100,000 for the year.

Shane-CPA :

$17,000 as an employee and $20,000 (20% of $100,000)

Shane-CPA :

You may be able to contribute more for a catch-up contribution if you are over the age of 50

Customer:

i am 37

Shane-CPA :

okay....then the catch-up contribution would not apply

Customer:

thanks for your patience, if you could tell me if i put 37k in 401k then how much taxes will i have to pay or on what amount i will have to pay taxes?

Shane-CPA :

sure...I will help you calculate this...

Customer:

thanks!

Customer:

if i make 120k and put 37k in 401 then I will be paying taxes on what amount

Shane-CPA :

Since the $37k will come from pre-tax dollars, you would pay tax on $83,000 ($120,000 - $37,000)

Customer:

or will i be paying taxes on 120k -37k ie 83

Customer:

ok

Shane-CPA :

however, you will also receive additional deductions against the $83k for federal tax purposes

Shane-CPA :

such as the standard deduction (or itemized deductions) and personal exemptions for you, your spouse and dependents

Customer:

to conclude this is there anything else you suggest anything else?

Shane-CPA :

you will also receive a deduction for 1/2 of your self-employment tax

Shane-CPA :

Since many CPA Firms provide free consultations, you may want to schedule an appointment so they can help you determine estimated tax payments and to provide your the benefits of the SEP IRA vs. the Traditional 401(k) so you can see it in person.

Shane-CPA :

For 2013 you will want to get in the habit of making quarterly estimated tax payments

Customer:

thanks for your excellent service!

Shane-CPA :

You're very welcome! Thank you for allowing me to assist you. If you are completely satisfied with the service I provided you today, please provide me with positive feedback so that I may receive credit for my response. If you feel exceptional service was provided, bonuses are greatly appreciated. If I can be of further assistance, please let me know. Have a great day!

Shane-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 265
Experience: Shane Northrop is a Certified Public Accountant, Personal Financial Specialist and a Chartered Global Management Accountant
Shane-CPA and 4 other Tax Specialists are ready to help you
Expert:  Shane-CPA replied 1 year ago.
Hi HG...This is Shane CPA from Just Answer. I assisted you with your question a few days ago. I wanted to follow up with you to see if my response has met your needs and if there are additional questions I can help you with.

Please let me know if I can be of service to you at any time!

I look forward to hearing from you!

Best Regards,
Shane, CPA

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