Every once in awhile we will get a client that decides at the last minute to tell us they earned some money on the side. This can be anything from selling Mary Kay to flipping a house. Maybe they even started a side business. Whatever the case may be, these ways of earning money on the side have tax consequences. When we are given this information right before we begin to file the tax return, there isn’t a whole lot we can do from a tax planning standpoint. This case involves a client that we will call Sally and will illustrate the importance of communicating with your accountant more than just once a year.
Sally has a full time job that allows her to have a pretty flexible schedule. She can do a lot of her work from home. So she decided that she could make some money on the side selling real estate. She contacted me shortly after she got started to ask some questions about record keeping, setting money aside for taxes, what types of business deductions she could take, etc. Sally is pretty sharp and knew a lot of what I was telling her but just wanted to make sure she covered all her bases.
Shortly after the year ended, she contacted me to set up a meeting to go over all of her numbers. I ran some tax projections for her to show her what her tax liability would look like. We took things a step further and discussed some ways to save money on taxes even after the year had ended. We started to discuss her starting a Simplified Employee Pension IRA (SEP-IRA). This is basically an IRA for self employed individuals. She had until the due date of the return to set up and contribute to the SEP-IRA in order to get a deduction on the current years return.
I ran some more numbers to let her know the max she could contribute. This is important because I have had clients in the past not consult me first and just open a retirement account and dump money into it not knowing there is a maximum amount you have to figure based off of your self employment earnings.
Sally ended up having more than enough to contribute the max amount which in her case was right around $2,000. She had been setting aside money for taxes but we ended up saving her enough through various deductions that she had some money left over. By contributing the $2,000 to retirement she ended up saving a little over $600 in taxes. This tax savings couldn’t have happened without Sally being proactive and putting a plan together before it was too late. (Side note: The best deductions are the ones where you get to put your money into some type of savings vehicle and get a tax deduction for it. That’s why I’m such a big fan of Health Savings Accounts.)
The ultimate take away from this case study is to stress the importance of tax planning. Things like starting a business, loss of a job, buying or selling a house, or having a child are all examples where tax planning can be very beneficial. Only talking to your accountant when it’s time to file your return can cause added stress to both you and your accountant.
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