What are some tax strategies for when you are self-employed with low income, but every 4-8 years you get a huge spike of income?

Question

I am self-employed in the United States, and am working on long-term projects. Most years I don't make much (lets say $20k), but every 4-8 years, after a large project is complete, I expect to get a big spike of income (lets say $200k). I would get taxed that year at a high rate, around 33%, even though if you had averaged out my income over the years, it would warrant closer to a 22% tax bracket.

Is there a way I can structure things so that the income gets more or less averaged out over the years? Right now I just have an LLC and pass through all my income. Maybe I could benefit from some kind of salary structure? I'm not that well versed in tax things, so I might be missing some options.

Thanks!

Answer 1

You must talk to a tax professional who can assess your individual situation, and can give you professional advice. The internet does not know your risk factors, personal goals, net worth, skill level, etc. The following answer makes a lot of assumptions, and will not match your personal situation.

Currently, in the U.S.

You're self employed, so you're likely filing taxes on a Schedule C as a sole proprietor. If you claim losses for 3 out of 5 years, the IRS can prohibit you from claiming losses again.

Unless you're closing shop for those 4-8 years, then most likely you are meeting performance obligations over that time. On the Schedule C, you should elect to pay taxes on the accrual basis and record income on your company's books as you meet performance obligations. This can be evenly spread out over time, or when you reach milestones set forth in a contract. If your business grows, eventually ASC Topic 606 will apply to you, and you will be required to recognize income over time.

When reporting income on the accrual basis on your Schedule C, you will need to pay taxes on the down years, but since you pay ordinary tax rates on your business income, spreading it out can put more income in the lower tax brackets.

Example

You get hired to build a website that takes 5 years to build for some reason. You'll get paid $100K when complete.

• Year 1:
  Accounts Receivable $20K Debit
  Revenue $20K Credit
  
  Pay tax on $20K revenue minus your expenses
  
  
• Year 2:
  Accounts Receivable $20K Debit
  Revenue $20K Credit
  
  Pay tax on $20K revenue minus your expenses
  
  
• Year 3:
  Accounts Receivable $20K Debit
  Revenue $20K Credit
  
  Pay tax on $20K revenue minus your expenses
  
  
• Year 4:
  Accounts Receivable $20K Debit
  Revenue $20K Credit
  
  Pay tax on $20K revenue minus your expenses
  
  
• Year 5:
  Accounts Receivable $20K Debit
  Revenue $20K Credit
  
  Cash $100K Debit
  Accounts Receivable $100K Credit
  
  Pay tax on $20K revenue minus your expenses

Hope this helps point your research in the right direction.

Answer 2

Well, if the LLC were taxed as a corporation then the federal tax rate would be 21% regardless of the amount of profit.

The problem is that dividends from a corporation face double taxation. So regular salary is likely the only financial reward taken out of the company. Or I suppose that a bonus salary is reasonable at a time of a large successful project.

So much of the wealth of the enterprise would likely stay contained in the value of the corporation so as to avoid the double taxation of dividends. Now for instance, an issuer corporation avoids being regulated as an investment company if it's wealth portfolio is 60% or more in Treasury Securities or cash.

Answer 3

Let's use $200,000 as an example

The LLC makes it very easy to account for the automatic 20% tax deduction. This would be $40,000, dropping the remaining to be taxed (AGI) down to $160,000.

The additional income lets you shelter and defer up to $57,000 (at time of writing) into a Solo 401k. Dropping the remaining to be taxed down to $103,000.

And then some of the consumptive purchases you might be interested in, such as new computers, are also going to be used for your work so you can consider deducting them as well, but be careful with that.

If you are borrowing and spending on business/entrepreneurial purposes, the interest payments are also deductible, and the things you bought are likely expenses too, so the leverage can greatly exceed your income at this point, dropping what goes to the government down to zero. You have to pay the people you borrowed from instead. This only works when you expect future growth, and even then it can result in bankruptcy, or things go as expected.

Not advice and definitely not tax advice, it is some people's reality. Consult a lawyer.

Hope that inspired!