BENEFITS

Traditional IRAs

Did you know that the self employed can also benefit from many of the retirement savings tax benefits regular 9-5'ers take advantage of? One of the simplest savings options available to entrepreneurs is the individual retirement arrangement (IRA). Traditional IRA's allow you to contribute a portion of your income to your retirement account without paying income tax on your contributions until you withdraw them (presumably when you retire). Because income tax on your contributions is deferred, your contributions (subject to IRS limits) are deductible in the year you make them, which can create a nice tax break for many entrepreneurs.

UBER DRIVER / RIDESHARE

Luke is a full-time Uber driver during the year earned $52,000 of self employment income from his ride share business. Rather than pay income tax on all of his self employment income this year, Luke chose to contribute $5,500 to his IRA to minimize his current tax liability and set himself up for retirement. When Luke prepares his taxes, he will be able to deduct the full $5,500 on line 32 of his Form 1040. Note however that after he begins to take distributions from his IRA, he will have to pay income tax on his contributions.

TASKER

In January, Jill quit her corporate job to take a year off before leaving for the Peace Corps. During her time off, she lived off of her savings but periodically sourced work through TaskRabbit, installing home entertainment systems. During the year, Jill earned $4,500 through TaskRabbit. She had no other income. Since Jill didn't really need the money to get by, she chose to put $1,500 of it into her IRA. Since her contribution was less than $5,500 and her total compensation, the full amount of her contribution would be deductible when she prepares her taxes.

REAL ESTATE AGENTS

Ian is a real estate agent in Scottsdale, Arizona. During the year he earned $165,000 of commission income and chose to contribute $8,000 to his traditional IRA. Unfortunately, since IRA contributions durng the year were limited to $5,500, Ian would not be able to deduct the full $8,000. Rather, he would need to complete Form 8606 and deduct $5,500. Additionally, he would have to pay a 6% tax on his $2,500 of excess contributions. To avoid paying the 6% tax in subsequent years, if Ian only contributes $3,000 ($5,500 limit less $2,500 excess contribution) the following year, he could "roll over" last year's excess contribution of $2,500.

LANDLORD

Harold is a 55-year-old landlord with multiple long-term residential rental properties. During the year he had $45,000 of rental income and $65,000 of W-2 wages. When Harold is calculating how much he can contribute to his IRA, he should exclude his $45,000 of rental income from his overall compensation. Since his compensation of $65,000 (W-2 wages only) is greater than the current year contribution limit $5,500, he would only be able to contribute $5,500 to his IRA, plus an additional $1,000 "catch-up" contribution since he is over the age of 50.

COURIER

Lisa is a 23-year-old full time Postmates messenger who made $43,000 last year. Since Lisa is a long-term thinker, she chose to contribute $5,000 to her Roth IRA. When she prepares her taxes, she would not be able to deduct any of her Roth contribution, since Roth contributions are after-tax. While Lisa won't catch a tax break this year, when she begins to make withdrawals from her Roth IRA later in life she likely won't owe income tax on her distributions.

WHAT TO KNOW ABOUT TRADITIONAL IRA DEDUCTIONS

If you contribute to a traditional IRA you could deduct the lesser of $5,500 (in 2018) of contributions or your compensation (includes self-employment income). Further, if you are age 50 and above, you are allowed to contribute and deduct an additional $1,000 catch up contribution, increasing your limit to the $6,500 of contributions or your compensation.
If your contributions exceed the limits defined by the IRS, excess contributions will not be deductible. Additionally, you could be subject to a 6% recurring annual tax on your excess contributions (and any earnings on your excess contributions) if you do not withdraw them by the due date of your tax return. If you do not withdraw your excess contributions, you can however apply them to subsequent contributions to avoid the 6% tax in future years. If you make a contribution to a traditional IRA that is above the IRS limit, use Form 8606 to determine the taxable amount of your excess contributions.
For the purposes of calculating your allowable IRA deduction, compensation can include but is not limited to self employment income, commissions, wages and bonuses. Note that compensation does not include investment income or rental property income, among other things. When calculating your compensation from self employment income, you should reduce your self employment income by retirement plan contributions and your self employment tax.
While traditional IRA contributions are before-tax (deductible from income), Roth contributions are after-tax and therefore not deductible. Roth IRA's share many of the same rules as traditional IRAs, however, one major difference is that the Roth contribution limit (lesser of $5,500 or compensation), will be reduced if your modified adjusted gross income (MAGI) exceeds $120,000 / $189,000 (married) in 2018. Taxpayers are ineligible to contribute to a Roth IRA when their MAGI exceeds $135,000 / $199,000 (married). While Roth contributions are not deductible, there are many benefits associated with Roth IRA's, you should consult with your tax advisor to understand more about the benefits of Roth IRA's.
Contributions to your traditional IRA can be deducted on line 32 of your Form 1040. Self employed individuals should not record contributions to their IRA on Form Schedule C.
The rules surrounding IRA's can be complex. There are many detailed rules that we have not included on this page (including rollovers and distributions). Different guidance may apply to you depending on your specific situation. Further, IRA's are just one of many investment vehicles you could choose to take advantage of. You should consult with your tax advisor and financial planner to determine how this deduction could apply to you specifically.

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IRS PUBLICATION

Contributions to IRAs

IRS PUBLICATION

Retirement Plans

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