Side work and managing finances?

Question

I recently started taking on some side work which is making a decent amount of money for me on the side. I am operating it under my own SS# currently and not an LLC. I was hoping someone could provide me with some tips on how to properly manage the side work income so I am not biting a large uncle sam bullet at the end of the year. I have searched this site and found some helpful answers already but not all that I was hoping to have answered. I am a software developer so of course my side work is working for a client creating a piece of software which doesn't have much over head other than just my time. So here it goes..

1) Tax write offs? Do I have to have a LLC established in order to use business type tax write offs? I honestly do not have much, I bought a printer so I could print out some items required for the job and that is all I really use it for. I was possibly thinking about upgrading my laptop to a newer higher end laptop so I could be more efficient with my work. I don't drive anywhere and I do not see much else I could write off. I do not have an office as I work right in my living room so I am assuming I could not write any part of that off either. We do now and then have business lunches to discuss the project in a central location but I do not feel that is a big line item either. Do I need an LLC for the write offs and with the little bit if any that I have would it even be worth it?

2) Finding a Tax Professional/Financial Adviser? I would like to speak with someone about my tax situation and probably more of a Financial Advisor. I am at a point with my income level that I feel my money could probably be managed a little better and I am looking for some guidance. How do you chose someone that you can trust their advise and how can you verify their experience? Would you trust someone that is purely online or would it be best to have someone in person? I do not know anyone else who uses a financial advisor so I cannot really reach out for personal recommendations. Also, how much do Financial Advisers usually charge and what is the frequency I should be consulting them?

3) Paying Taxes? The side work I am performing will be claimed by my client but I am essentially doing a 1099 (though I do not recall filling one out) so I am getting 100% pay with no taxes taken out. I was reading in another post my tax bracket is around 28%, what is the best way to handle putting that money aside? I unfortunately have burning bank accounts and the moment money lands in them it gets spent due to honestly partially my lack of self control, some "emergency need", my wifes need to spend, and my childrens general needs. Is there a way to pay the government as I go or do I have to hold onto this tax money for a year and pray I saved enough to cover the taxes? I am one who prefers to pay my bills in advanced or immediately when they come in so I know that responsibility is taken care of. I struggle with holding on to money for longer periods of time.

4) Side Work Money Division? The side money I am bringing in is basically all profit, I have no really needs for the money so I am freely spending it. I feel guilty as I feel I should be utilizing this money a little wiser. I have some debts, credit cards(just 2), cars(2), house, and accounts on my credit that need to be paid off even though I do not agree with them as they are medical from car accidents related to a lawsuit I'm currently pursuing against the at fault party. I feel I should be allocating a % of this income to different locations of my life like Taxes, Savings, Debts, Investing, and of course FUN/Materials! I was wondering if there is a recommended split or a good rule of thumb that would help me better allocate my money. Right now it all just goes towards materials, paying of some debts, and weekend getaways, the paying debts makes me feel not so guilty but I feel there could be a better allocation of my funds. Any rule of thumbs or good practices when allocating "extra" money?

Well I have a bunch more questions but I have a feeling I will be told this post is too long so I will stop here. Any recommendations would be appreciated, especially in the realm of finding a trustworthy, educated financial adviser.

Answer 1

I have done similar software work. You do not need an LLC to write off business expenses. The income and expenses go on Schedule C of your tax return. It is easy to write off even small expenses such as travel - if you keep records. The income should be reported to you on a 1099 form, filled out by your client, not yourself.

For a financial advisor you should find one you can visit with personally and who operates as a "fee-only" advisor. That means they will not try to sell you something that they get a commission on. You might pay a few $hundred per visit.

There are taxes that you have to pay (around 15%) due to self-employment income. These taxes are due 4 times a year and paid with an "estimated tax" form. See the IRS web site, and in particular schedule SE. Get yourself educated about this fast and make the estimated tax payments on time so you won't run into penalties at the end of the year.

Answer 2

I've done various side work over the years -- computer consulting, writing, and I briefly had a video game company -- so I've gone through most of this. Disclaimer: I have never been audited, which may mean that everything I put on my tax forms looked plausible to the IRS and so is probably at least generally right, but it also means that the IRS has never put their stamp of approval on my tax forms. So that said ...

1: You do not need to form an LLC to be able to claim business expenses. Whether you have any expenses or not, you will have to complete a schedule C. On this form are places for expenses in various categories. Note that the categories are the most common type of expenses, there's an "other" space if you have something different.

If you have any property that is used both for the business and also for personal use, you must calculate a business use percentage. For example if you bought a new printer and 60% of the time you use it for the business and 40% of the time you use it for personal stuff, then 60% of the cost is tax deductible. In general the IRS expects you to calculate the percentage based on amount of time used for business versus personal, though you are allowed to use other allocation formulas. Like for a printer I think you'd get away with number of pages printed for each. But if the business use is not 100%, you must keep records to justify the percentage. You can't just say, "Oh, I think business use must have been about 3/4 of the time." You have to have a log where you write down every time you use it and whether it was business or personal.

Also, the IRS is very suspicious of business use of cars and computers, because these are things that are readily used for personal purposes. If you own a copper mine and you buy a mine-boring machine, odds are you aren't going to take that home to dig shafts in your backyard. But a computer can easily be used to play video games or send emails to friends and relatives and lots of things that have nothing to do with a business. So if you're going to claim a computer or a car, be prepared to justify it.

You can claim office use of your home if you have one or more rooms or designated parts of a room that are used "regularly and exclusively" for business purposes. That is, if you turn the family room into an office, you can claim home office expenses. But if, like me, you sit on the couch to work but at other times you sit on the couch to watch TV, then the space is not used "exclusively" for business purposes. Also, the IRS is very suspicious of home office deductions. I've never tried to claim it. It's legal, just make sure you have all your ducks in a row if you claim it.

Skip 2 for the moment.

3: Yes, you must pay taxes on your business income. If you have not created an LLC or a corporation, then your business income is added to your wage income to calculate your taxes. That is, if you made, say, $50,000 salary working for somebody else and $10,000 on your side business, then your total income is $60,000 and that's what you pay taxes on. The total amount you pay in income taxes will be the same regardless of whether 90% came from salary and 10% from the side business or the other way around. The rates are the same, it's just one total number.

If the withholding on your regular paycheck is not enough to cover the total taxes that you will have to pay, then you are required by law to pay estimated taxes quarterly to make up the difference. If you don't, you will be required to pay penalties, so you don't want to skip on this. Basically you are supposed to be withholding from yourself and sending this in to the government.

It's POSSIBLE that this won't be an issue. If you're used to getting a big refund, and the refund is more than what the tax on your side business will come to, then you might end up still getting a refund, just a smaller one. But you don't want to guess about this. Get the tax forms and figure out the numbers.

I think -- and please don't rely on this, check on it -- that the law says that you don't pay a penalty if the total tax that was withheld from your paycheck plus the amount you paid in estimated payments is more than the tax you owed last year. So like lets say that this year -- just to make up some numbers -- your employer withheld $4,000 from your paychecks. At the end of the year you did your taxes and they came to $3,000, so you got a $1,000 refund. This year your employer again withholds $4,000 and you paid $0 in estimated payments. Your total tax on your salary plus your side business comes to $4,500. You owe $500, but you won't have to pay a penalty, because the $4,000 withheld is more than the $3,000 that you owed last year. But if next year you again don't make estimated payment, so you again have $4,000 withheld plus $0 estimated and then you owe $5,000 in taxes, you will have to pay a penalty, because your withholding was less than what you owed last year. To you had paid $500 in estimated payments, you'd be okay. You'd still owe $500, but you wouldn't owe a penalty, because your total payments were more than the previous year's liability. Clear as mud?

Don't forget that you probably will also owe state income tax. If you have a local income tax, you'll owe that too.

Scott-McP mentioned self-employment tax. You'll owe that, too. Note that self-employment tax is different from income tax. Self employment tax is just social security tax on self-employed people. You're probably used to seeing the 7-whatever-percent it is these days withheld from your paycheck. That's really only half your social security tax, the other half is not shown on your pay stub because it is not subtracted from your salary. If you're self-employed, you have to pay both halves, or about 15%. You file a form SE with your income taxes to declare it.

4: If you pay your quarterly estimated taxes, well the point of "estimated" taxes is that it's supposed to be close to the amount that you will actually owe next April 15. So if you get it at least close, then you shouldn't owe a lot of money in April. (I usually try to arrange my taxes so that I get a modest refund -- don't loan the government a lot of money, but don't owe anything April 15 either.) Once you take care of any business expenses and taxes, what you do with the rest of the money is up to you, right? Though if you're unsure of how to spend it, let me know and I'll send you the address of my kids' colleges and you can donate it to their tuition fund. I think this would be a very worthy and productive use of your money. :-)

Back to #2. I just recently acquired a financial advisor. I can't say what a good process for finding one is. This guy is someone who goes to my church and who hijacked me after Bible study one day to make his sales pitch. But I did talk to him about his fees, and what he told me was this: If I have enough money in an investment account, then he gets a commission from the investment company for bringing the business to them, and that's the total compensation he gets from me. That commission comes out of the management fees they charge, and those management fees are in the same ballpark as the fees I was paying for private investment accounts, so basically he is not costing me anything. He's getting his money from the kickbacks. He said that if I had not had enough accumulated assets, he would have had to charge me an hourly fee. I didn't ask how much that was.

Whew, hadn't meant to write such a long answer!