Archives for December 2021

When it comes to retirement, we all think of contributions to 401K plans. Many employers offer 401K plans to their employees for retirement savings. Contributions towards these plans are automatically withdrawn from your salary and invested in the funds you choose.

Many times, employers offer to match a portion of what you save, usually between 4% and 6% of your pay. This offer makes it an attractive retirement savings avenue.

Traditional 401K

In case of a traditional 401K plan, the employer takes out the contributions pre-tax, which means the amount of contribution reduces your taxable income, thereby reducing the tax amount you’ll owe at the end of the year. Just a side note here: you will still pay payroll taxes on your 401K contributions. Conversely, when you take out distributions from your 401K plan, you will have to pay income tax on the distributions at the tax rate that applies when you take the money out. The advantage is that if your current tax rate is high compared to the estimated tax rate when you retire, then you will pay less tax on the contributed amount. The disadvantage is that you will pay tax on the earnings accumulated in your traditional 401K as you take them out.

Roth 401K

However, in the case of a Roth 401K though, the contributions are not pretax, so they do not reduce your taxable income. But conversely, when you take the money out of your Roth 401K you will not pay tax on the amount contributed and you will not pay tax on any earnings in your Roth 401K. But you will pay tax on any employer matching contributions, which will go into a separate traditional 401K account.

401K Contribution Limits

It is important to note that these contributions do have limits. There is a limit on how much you, as an employee can contribute and there is an overall limit on contributions towards your account that includes contribution by you, your employer matching and elective deferrals. The IRS taxes any excess contributions not withdrawn by April 15th at a rate of 6% per year for each year the excess contribution amount remains in the account.

 In a recent news release, IRS announced an increase to these limits. For 2022 you, as an employee can contribute up to $20,500 while keeping the combined contribution limit towards your 401K plan to the lesser of 100% of your compensation or $61,000. It is important to note that the IRS has not announced any change in the catchup contribution amount available to you if you are 50 years and above. It remains at $6,500 for 2022.

If you need help with your federal or state taxes, give us a call or schedule an appointment.

This material is for informational purposes only. It does not constitute tax, legal or accounting advice.

All of us have hobbies and some of us can even generate income from a hobby. In recent times with the popularity of e commerce, selling a product, like handmade jewelries is within the reach of everyone. Even though you might engage in such hobbies not with an intention to run a business, but to generate some side income, remember you have to report your hobby income on your income tax return.

Hobbies Are Not Tax Efficient

Hobbies are fun, but do cost money and they are not tax efficient. Why?

• You cannot claim a loss
• You cannot claim the operating expenses. But you can claim the cost of goods sold, which is allowed to be deducted from the hobby income.
• You have to report gross hobby income less cost of goods sold

You might be able to use the operating expenses after 2025, but generally only as a miscellaneous deduction subject to 2% adjusted gross income limitation and only if you have enough itemized deductions to be able to itemize on schedule A of your personal tax return.

For these reasons you have to understand if you can report your hobby as a business and claim ALL your expenses as a reduction to income.

When Can You Report Your Hobby As a Business?

To consider a hobby as a business you need to answer questions like:

• Do you maintain complete income and expense records of your hobby just like a business would?
• Do you make a profit or intend to make changes to your method of operation so as to make a profit?
• Are you trained or do you have the knowledge necessary to carry out the activity as a business?
• Do you depend on this activity to generate income for your livelihood?
• Do you put necessary time and effort to make the activity profitable?

If you find yourself answering YES to these questions then you might qualify to report your activity on schedule C of your personal income tax return, reporting this way only the net income (after ALL expenses). One other tax advantage of having a business instead of a hobby is that you can use the qualified income deduction (generally 20% of your business net income, with some limitations).

To see all the 9 factors the IRS looks at when determining if an activity is a hobby or a business, click here.

On the other hand, the disadvantage of reporting your activity as a business is that you have to pay self-employment tax (approximately 15.3%) on the net income, while the hobby income is not subject to self-employment tax.

If you need help on how to report your hobby or business activity, click here to schedule an appointment.

This material is for informational purposes only. It does not constitute tax, legal or accounting advice.