Roth IRA and FAFSA

[bbpiano1]

M2 here. Been working on the side as an SAT/MCAT tutor and was paid cash (too little to file a tax return). If I put down '0' as my income on the FAFSA, can I still contribute to a Roth IRA? Or do I need to somehow revise my FAFSA to read income=$900 and then contribute the $900 to an IRA?

Or are the two just completely unrelated?

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[AndyFromMDTAXES]

I would say that the amount you can contribute to your Roth IRA is a function of what you report on your federal income tax return. And if you earn more than $400 in self-employment earnings, you're supposed to file a tax return.

I would also say that what you report on your FAFSA should be equivalent to what you report on your federal income tax return.

So even though you'll owe no income taxes if the $900 is your only income, you will owe "self-employment taxes" on that income at a rate of 15.3%. The self-employment tax is the social security tax paid by people who are self-employed. When you work for an employer, your employer withholds social security and Medicare taxes at a rate of 7.65%, and then matches the amount they withhold. When you're self-employed, you pay that 15.3% tax yourself as part of your federal tax return.

For more info, take a look at the Schedule SE available at www.irs.gov.

 

[bbpiano1]

Thanks Andy. Quick follow-up.

Hypothetically, say a med student earned $1000 tutoring for the SAT and was paid in cash. Do you think it would be better to file, pay 15% tax, and then throw the money into an IRA? Or would it be more prudent to keep the money in a sock drawer?

I was looking at the student section of the IRS website and it seems like you can deduct business expenses. I'm guessing my computer (for coming up with lesson plans), car (partly), pencils, paper, can be deducted.

 

[AndyFromMDTAXES]

That's right. When you get paid a fee for a service, you can claim your related expenses directly against that income. Against tutoring income you can deduct mileage driving to the student, supplies, internet access, cell phone, and any other expense "ordinary" and "necessary" in connection to earning that income. You report your income and related expenses to the IRS on a Schedule C as part of your federal tax return.

Obviously, if your income is only $1,000, you wouldn't deduct 100% of your cell phone and internet access for the year. Even so, I don't think you would have any problem coming up with more than $600 of expenses, which would be sufficient for you to not file a tax form for this year.

So should you report the $1,000 in income, pay $141 in self-employment taxes, and contribute $930 to a Roth IRA? Depends on your financial situation. If you have the $1,071 to spare, and you think the government won't change the Roth IRA rules down the road, then it might be worth considering. (How's that for a non-answer?)

 

[bbpiano1]

Wow, you really seem to know a lot about this subject. So now that I've made a list of $600+ worth of deductions, I don't have to file a tax return.

But can I still put the $1000 in an IRA even though I don't have to file. Or is it just the $400 leftover that's eligible to be put in an IRA?

Thanks for the help, Andy. You've been great!

 

[AndyFromMDTAXES]

The amount you can contribute to your Roth is your net self-employment income reduced by half of your self-employment tax. So if you have $600 in expenses to claim against your $1,000 in income, and have no other income, then you would be able to contribute $400 to your Roth IRA this year.

 

[UserNameNeeded]

AndyFromMDTAXES, are you sure?

I was told you can contribute your entire GROSS earned income to your Roth IRA.

 

[AndyFromMDTAXES]

That's a vaild point. Actually, the amount you can contribute to your Roth is based on your "Adjusted Gross Income". To calculate your AGI, you include your NET self-employment income as reflected on your Schedule C.

So if you have self-employment income, the amount you can contribute to your Roth is reduced by the expenses you claim directly against that income. If you show on your Schedule C that you earned $5k in consulting income, and had $6k in expenses to claim directly against that income, and that's your only source of income, then you would not be allowed to contribute to a Roth that year.

I have self-employed clients ask me all the time if it makes sense to report fewer expenses against their independent contractor income, which which would allow them to put away more money into their retirement accounts. The problem is that there is a cost to this strategy in the form of higher taxes.