Reducing Taxes shows you how to easily and legally use the tax laws to earn money as one of our teachers and yet pay less in taxes.
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Did you know our tutors can easily and legally reduce their taxes by claiming many deductions not available to salaried employees? Were you aware that earning $20 an hour as a tutor can net you as much after-tax income as earning $50 per hour from a part-time job? If facts like these interest you, read on because what you're about to learn can save you hundreds or even thousands of dollars.
We all look for ways to avoid taxes. Unfortunately, most tutors don't know they can simply and legally shelter much of their tutoring income from the tax collector. As a result, they end up paying a lot more in taxes than necessary.
First, you need to know there are basically two ways to earn income: as a salaried employee and as an independent contractor. Salaried employees have Social Security, Federal and other taxes withheld from each paycheck and their wages are reported at year's end on a W-2 form, Teachers, substitute teachers, guidance counselors and after-school program workers are usually salaried employees. Independent contractors receive their full earnings in each paycheck with nothing withheld and their wages are reported at year's end on a 1099 form. Most self-employed people and consultants are independent contractors. If your take-home or net pay is always less than your earnings, you're probably a salaried employee. If your take-home pay always equals your earnings, you're probably an independent contractor.
If you tutor for us, you're NOT a salaried employee: rather, you're an independent contractor. We don't withhold Social Security, Federal and other taxes from your pay. We're required only to report annual earnings of ^600 or more on a 1099 form. Payment of any taxes due is solely your responsibility.
Legally, you're viewed as a completely separate tutoring service with one employer (you) and one employee (you). After our service signs up students, we subcontract them to your service for lessons. Since your tutoring income and expenses are business related. you can shelter much of your income by keeping a record of all expenses incurred in conducting lessons and reporting to us. These include all travel expenses, charges for calls and mailing to us and students, materials you buy for lessons, expenses incurred at certain educational programs you attend to sharpen your tutoring skills, etc. If you drive to lessons, your travel expenses include a mileage allowance ($.32˝ per mile was the rate in 2000; it goes up a penny or two per mile each year), parking and tolls. You can even invest up to $6,000 of your tutoring income in a retirement plan separate from any IRA and pension plan you now have. Consult your accountant or the IRS for complete information about all these possible deductions which are available only to independent contractors, and not to salaried employees.
You need to use some sort of diary or appointment book to maintain a log of your tutoring expenses. You don't need receipts for any expenses under $25 as long as you detail them in your log. Just write the date, location, amount and purpose of each expense. When you prepare your taxes on a 1040 form, itemize them on a Schedule C, add them up, subtract the total from your tutoring income and include the resulting profit or loss with your total income from all sources.
Suppose one year John Tutor reported independent contractor earnings of $6,000 (300 hours at $20 per hour) and expenses of $3,000 on Schedule C. His taxable tutoring income would be $3,000, not $6,000. If his Federal (about 28%), State (about 7%), City (about 4%) and Social Security (about 10%) tax rates total about 50%, he'd pay about 50% of $3,000 or $1,500, not $3,000 in taxes, a savings of $1,500. He'd have had to tutor 75 extra hours to earn the $1,500 he'd save in taxes.
Doubtless, you've heard about regular IRA's and Roth IRA's. However, you're probably not familiar with SIMPLE IRA's. SIMPLE IRA's became available January 1, 1997 as retirement plans for small businesses with 100 employees or less. (SIMPLE is an acronym for "Savings Incentive Match Plan For Employees".) As a self-employed, private tutor, you're legally a small business with one employee (you--you're the owner) and one employee (you--you're the tutor). Since any small business like yours is entitled to set up a SIMPLE IRA plan for its employees, you can set up one for yourself, even if you're a full-time, salaried employee with a pension plan and a regular IRA, even if you're a retired person collecting Social Security and a pension and even if you're over 70˝.
What's a SIMPLE IRA? Basically, it's just like a regular IRA, but with these differences: 1) You can contribute up to $6,000 per year of your tutoring income. (So, if your tutoring income is $4,000, you can contribute all $4,000 of it. If you earn $9,000, you can contribute up to $6.000.) 2) You can contribute without to your full-time job's salary or pension plan. 3) You can contribute at any age as long as you continue tutoring. Like regular IRA's, all contributions and gains are tax-deferred until withdrawn, you can't touch it until you reach 59˝ and you must start making withdrawals when you reach 70˝. Custodial fees are the same as for regular IRA's, usually no more than $10 per year.
How can you learn about SIMPLE IRA's? Simple! (No pun intended.) Since most people invest their IRA's in mutual funds, here are three companies which offer complete details: American Century, INVESCO Funds and The Vanguard Group.
Let's return to John Tutor. As you recall, he earned $6,000 as a tutor, reduced his taxable income to $3,000 and, as a result, paid $1,500 in taxes instead of $3,000. Now, let's assume he contributed all $6,000 to a SIMPLE IRA. His schedule C would now show expenses of $9,000 ($6,000 for the SIMPLE IRA and $3,000 in other expenses) against earnings of $6,000. This comes to a loss of $3.000 and would reduce his total income for the year by $3,000. As a result, he'd end up paying about $1,500 less in taxes. This point is very important and bears repeating. By earning $6,000 as a tutor and using Schedule C as indicated above, John Tutor's taxes DO NOT INCREASE BY $3.000. Rather, they'd decrease by about $1,500 and his retirement fund would have grown by $6,000. If John had earned the $6,000 as a part-time salaried employee, he'd have paid an extra $3.000 in taxes, rather than saving $1,500. That's a difference of $4,500 [$3,000-(-$1,5000)]. Even in this day and age, that's a lot of money. Paying an extra $4,500 in taxes would be like tutoring an extra 225 hours without being paid.
We've seen how tutors can substantially reduce taxes by claiming deductions not available to salaried employees. Now, let's see how an independent contractor earning $20 per hour as a tutor nets as much after-tan income as a salaried employee earning $50 per hour from a part-time job. Let's assume Harry Riche works 300 hours as a salaried employee at a part-time job paying $50 per hour. He'd gross $15,000 but, after paying about 50% in taxes, his take-home pay would be about $7,500. Let's compare his earnings to those of John Tutor. John Tutor worked 300 hours at $20 per hour, invested all of his $6.000 income in a SIMPLE IRA, saved $1,500 in taxes and, therefore, ended up $7,500 ahead. Even though Harry's hourly rate was higher than John's, both earned the same amount of money. Clearly, earning $20 per hour tutoring with us can net you as much as earning $50 per hour from a part-time job.
Consider these calculations very carefully. After all, we're not talking about nickels and dimes. We're talking about keeping thousands of hard-earned dollars in your own pockets. Check our figures and conclusions by recalculating them, reading the IRS and consulting an accountant. You'll soon realize that earning $20 an hour tutoring for us actually nets you more than earning $35 an hour working the same number of hours for the Board of Ed as a substitute teacher or in an after-school program.
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