Hey guys. Sorry for the slow reply. Thanks Cullen King for the shoutout. I'm traveling to meet a client so I wasn't able to check HN as often as I usually do.
I'll email him shortly later today to offer my help directly. But I'll post a few thoughts just so that anyone else in a similar position will be prepared.
Everyone pretty much hit the mark with the self-employment tax issue. SE Tax is a 15.3% tax that you have to pay on income earned from a business.
It sounds like the etymonline guy pretty much got hosed from paying income tax on the income but failure to pay the SE Tax.
Google issues 1099s to anyone that earns over 400 or 600 dollars so the IRS knows if you're making money.
But, from the sound of his explanation. His server and upkeep costs should've generated enough expenses to wipe out his income. I'd have to speak with him directly and more in depth but that is the impression he left in his plead.
Also, there are ways to avoid paying SE tax entirely. If you incorporate into a S Corp and pay yourself a reasonable income, the rest would be excluded from SE Tax. An Scorp is a passthrough entity which means that all income is not taxed twice like a regular Corp. You pay tax on the income once on your 1040. But because the scorp is still a corporation, then you wouldn't pay SE tax on that income because the distribution is a dividend. You don't pay SE taxes on dividends.
Also, it seems like the taxpayer isn't clear about his options once the audit has commenced. Luckily, I'm sure that the taxpayer could still plead his case if he has some facts that could help his situation.
But these are my initial thoughts on the situation. I'm going to email him now and see if he's interested in discussing the issue further.
I'll update everyone on this issue later on if he is willing to allow me to speak on the matter as a learning experience for everyone.
> Google issues 1099s to anyone that earns over 400 or 600 dollars so the IRS knows if you're making money.
Why do I feel like noting this could have saved more than a few words in the article; at the very least, how was it that this salient fact is never mentioned?
> Also, there are ways to avoid paying SE tax entirely. If you incorporate into a S Corp and pay yourself a reasonable income, the rest would be excluded from SE
Ditto. This one note seems a much more valuable takeaway than most everything in the article.
Not trashing the article, just that camz nails the important points with a greater economy of words.
Is you do incorporate you will need to pay corporate taxes, in addition the corporation will need to pay the employer portion of the SE tax. (So you don't pay it, the corporation does, and since they need to pay it they reduce your salary by that much, i.e. it's a wash.)
Becoming a corporation will not reduce your taxes, but it will significantly increase the complexity. The main benefit it liability, not financial.
If you create an S-Corp then you wouldn't pay corporate tax since an S-Corporation is a passthrough entity. Legally you are protected and tax-wise you only pay on the 1040, but you avoid SE Tax.
I could point you to a number of resources to clarify the issue, if your interested?
Hey ars, well the best way to explain the concept is to think about how you are taxed on dividends. When you buy stock in Google and receive dividends, you would pay tax on that income on your 1040, but it would not be taxed as a "self-employment income" and thus SE Tax is not levied.
An S-Corporation is a standard C-Corporation that has elected for special treatment. Instead of paying double taxation, its income is directly passed-through to the taxpayer. But, that does not change the character of the income. The income is still considered a "corporate distribution" or a dividend. Thus, it cannot be cannot be taxed under SE Tax rules because a dividend is not "self-employed income."
This rule is found at IRC § 1368 (c)(2) :
In the case of a distribution described in subsection (a) by an S corporation which has accumulated earnings and profits—
1368(c)(1) Treatises Accumulated adjustments account.
That portion of the distribution which does not exceed the accumulated adjustments account shall be treated in the manner provided by subsection (b) .
1368(c)(2)Dividend.
That portion of the distribution which remains after the application of paragraph (1) shall be treated as a dividend to the extent it does not exceed the accumulated earnings and profits of the S corporation.
1368(c)(3)Treatment of remainder.
Any portion of the distribution remaining after the application of paragraph (2) of this subsection shall be treated in the manner provided by subsection (b) .
But, note that you must pay a reasonable salary to yourself first to apply this tax strategy or plan. There are certain pitfalls that you must be aware of as with any tax plan.
I've always wondered what the proper criteria for "reasonable salary" were. Care to offer one of your wonderful Hacker News summaries on that matter?
By the way, it's great to see a qualified member of the HN community offering help to Etymonline. Do let us know if anything comes of it (he's says he's made contact with a local tax lawyer, but based on your reputation here, I'd rest easier if he were in your hands ;-).
Thanks pw, I've read his update on the situation and I've offered to help guide him through the decision of whether to incorporate his website as a business or as a non-profit as well as help actually incorporate his website.
I've yet to hear back from him, so I haven't had anything to update. I'm guessing that he feels comfortable with the information he learned from the tax attorney and is satisfied with the help he's received.
In regards to the "reasonable salary" issue that's a difficult topic to explain because its a subjective test. The word reasonable is going to be very different for the IRS compared to the average taxpayer.
In my experience, a "reasonable salary" is going to depend a number of factors. The best way to prove that you're getting a reasonable salary is to have "comps" or comparable positions with the same functions and them take the average of their salary.
Ex: Your job description is an entry level developer. Average salary is in the range of 55k to 75k but the mean is 60k. In this situation you could argue for any salary between 55k and 75k, but the clearest answer would've been 60k. Subjectivity please a big role in this area.
Also, experience has given me a "gut feeling" on what is reasonable so often times I go by just guessing based on what I've seen on the past.
Lastly, thanks for the props! I'm honestly surprised that anyone even bothers to read my posts about boring tax loll but I'm glad to have been of help =D.
I'll email him shortly later today to offer my help directly. But I'll post a few thoughts just so that anyone else in a similar position will be prepared.
Everyone pretty much hit the mark with the self-employment tax issue. SE Tax is a 15.3% tax that you have to pay on income earned from a business.
It sounds like the etymonline guy pretty much got hosed from paying income tax on the income but failure to pay the SE Tax.
Google issues 1099s to anyone that earns over 400 or 600 dollars so the IRS knows if you're making money.
But, from the sound of his explanation. His server and upkeep costs should've generated enough expenses to wipe out his income. I'd have to speak with him directly and more in depth but that is the impression he left in his plead.
Also, there are ways to avoid paying SE tax entirely. If you incorporate into a S Corp and pay yourself a reasonable income, the rest would be excluded from SE Tax. An Scorp is a passthrough entity which means that all income is not taxed twice like a regular Corp. You pay tax on the income once on your 1040. But because the scorp is still a corporation, then you wouldn't pay SE tax on that income because the distribution is a dividend. You don't pay SE taxes on dividends.
Also, it seems like the taxpayer isn't clear about his options once the audit has commenced. Luckily, I'm sure that the taxpayer could still plead his case if he has some facts that could help his situation.
But these are my initial thoughts on the situation. I'm going to email him now and see if he's interested in discussing the issue further.
I'll update everyone on this issue later on if he is willing to allow me to speak on the matter as a learning experience for everyone.