How can a student avoid paying high taxes?
April 9, 2010 4:33 AM Subscribe
I’m a student and it’s tax time. I work for my school (work study) and to help make ends meet I do consulting work (web programming) for a few reputable clients (meaning they don’t pay under the table). The problem with consulting work is that I get hammered come tax time. The 1040s are unforgiving.
Needless to say I know very little about taxes and the tax code.
I literally live month to month with very little overhead, because most of my efforts are focused on school. When calculating my apparent taxes (which might be on the order of $400-500) I don’t really see how I’m going to be able to pay them and pay rent.
What are some ways a student like me can get around having to pay such (relatively) high taxes? It really doesn’t make sense to me that I should give 15% of my income when I’m technically well below the poverty line (I may make $3,000-4,000 per year, not including scholarships and grants). I am totally for the idea of taxes though. I would pay if I could, but as of now it either seems pay taxes or pay rent.
What should I do?
Needless to say I know very little about taxes and the tax code.
I literally live month to month with very little overhead, because most of my efforts are focused on school. When calculating my apparent taxes (which might be on the order of $400-500) I don’t really see how I’m going to be able to pay them and pay rent.
What are some ways a student like me can get around having to pay such (relatively) high taxes? It really doesn’t make sense to me that I should give 15% of my income when I’m technically well below the poverty line (I may make $3,000-4,000 per year, not including scholarships and grants). I am totally for the idea of taxes though. I would pay if I could, but as of now it either seems pay taxes or pay rent.
What should I do?
I'm assuming this is all in the U.S.
A lot of the answers here are going to depend on whether you're claimed as a dependent on your parents. I'm assuming you are claimed as a dependent, since if you weren't, your taxable income (given the gross income you mention above along with the standard deductions and exemptions) should be zero. On the off-chance you're not claimed as a dependent, though, you're probably eligible for the new $400 Making Work Pay tax credit, and possibly for the Earned Income Credit as well depending on your age. If you are a dependent, make sure that you're still claiming the appropriate deduction from your income (there should be a worksheet in your tax instruction booklet instructing you how to calculate this if you're a dependent; it'll probably be no more than $950, but every little bit helps.)
More generally, the way that you're supposed to avoid owing large amounts of money in April is to make estimated tax payments throughout the year. It's a bit of a hassle, but at least you'll be less tempted to spend money in September that you would need to pay your taxes in April.
Finally, if you can't pay your tax bill right now, you can request an installment agreement from the IRS. Go to the this IRS webpage and select "Set Up a Payment Plan". You'll still owe the money (plus a little more in interest, probably), but at least you'll be able to make rent this month.
posted by Johnny Assay at 5:12 AM on April 9, 2010
A lot of the answers here are going to depend on whether you're claimed as a dependent on your parents. I'm assuming you are claimed as a dependent, since if you weren't, your taxable income (given the gross income you mention above along with the standard deductions and exemptions) should be zero. On the off-chance you're not claimed as a dependent, though, you're probably eligible for the new $400 Making Work Pay tax credit, and possibly for the Earned Income Credit as well depending on your age. If you are a dependent, make sure that you're still claiming the appropriate deduction from your income (there should be a worksheet in your tax instruction booklet instructing you how to calculate this if you're a dependent; it'll probably be no more than $950, but every little bit helps.)
More generally, the way that you're supposed to avoid owing large amounts of money in April is to make estimated tax payments throughout the year. It's a bit of a hassle, but at least you'll be less tempted to spend money in September that you would need to pay your taxes in April.
Finally, if you can't pay your tax bill right now, you can request an installment agreement from the IRS. Go to the this IRS webpage and select "Set Up a Payment Plan". You'll still owe the money (plus a little more in interest, probably), but at least you'll be able to make rent this month.
posted by Johnny Assay at 5:12 AM on April 9, 2010
Oh, and of course, I am not a tax lawyer, accountant, or anything of the sort; just a guy who recently completed his tax returns and wants to help a brother/sister out.
posted by Johnny Assay at 5:13 AM on April 9, 2010
posted by Johnny Assay at 5:13 AM on April 9, 2010
What are some ways a student like me can get around having to pay such (relatively) high taxes? It really doesn’t make sense to me that I should give 15% of my income when I’m technically well below the poverty line (I may make $3,000-4,000 per year, not including scholarships and grants)
Stop doing freelance and get a part-time position where taxes are automatically deducted from your paycheck--that way, you won't have to cough up the "extra" money for taxes during tax time. Make sure you're taking any tax credits you're eligible for, too, such as credits on any interest you might have paid on your student loans. And keep in mind that you can always pay any taxes owed via payment plans--definitely something to look into if you can't make the lump payment.
But really, taxes are taxes. One of only two things in life that are guaranteed etcetc.
posted by PhoBWanKenobi at 5:14 AM on April 9, 2010
Stop doing freelance and get a part-time position where taxes are automatically deducted from your paycheck--that way, you won't have to cough up the "extra" money for taxes during tax time. Make sure you're taking any tax credits you're eligible for, too, such as credits on any interest you might have paid on your student loans. And keep in mind that you can always pay any taxes owed via payment plans--definitely something to look into if you can't make the lump payment.
But really, taxes are taxes. One of only two things in life that are guaranteed etcetc.
posted by PhoBWanKenobi at 5:14 AM on April 9, 2010
I think what might be missing here is an understanding that people do not pay tax on every dollar received. Even once funds are counted as income (and as a general matter, income is all funds received unless they meet a specific, strict exemption), one may then take deductions against the income.
Think of yourself as having two piles of money: money you owe taxes on, and money you don't. The goal is to move as much from pile A to pile B as you can (legally). What you might feel better researching are deductions. Deductions come in two flavors: itemized (where you have a lot of specific deductions) and standard (anybody gets it, just for filing). The current deduction for a single person whom no one else is claiming as a dependent is $5,700. Generally, this moves $5,700 from pile A (on which you pay taxes) to pile B (on which you don't).
The above is a very general, simplified, generic overview. It's not advice for your situation. There are myriad specific instructions, special rules, tricks, limits, etc. You might see if your school has someone who can help you file for a discount. Also, one can typically set up payment plans so perhaps you can get some relief by spreading payments out?
posted by bunnycup at 5:27 AM on April 9, 2010 [1 favorite]
Think of yourself as having two piles of money: money you owe taxes on, and money you don't. The goal is to move as much from pile A to pile B as you can (legally). What you might feel better researching are deductions. Deductions come in two flavors: itemized (where you have a lot of specific deductions) and standard (anybody gets it, just for filing). The current deduction for a single person whom no one else is claiming as a dependent is $5,700. Generally, this moves $5,700 from pile A (on which you pay taxes) to pile B (on which you don't).
The above is a very general, simplified, generic overview. It's not advice for your situation. There are myriad specific instructions, special rules, tricks, limits, etc. You might see if your school has someone who can help you file for a discount. Also, one can typically set up payment plans so perhaps you can get some relief by spreading payments out?
posted by bunnycup at 5:27 AM on April 9, 2010 [1 favorite]
Based on your income, you probably don't owe any income tax at all. Your taxes are high, as you probably know, because of self-employment tax (aka payroll tax). There is nothing you can legally do about that (other than maybe decide to become Amish). You may need to charge more to your consulting clients if your fees don't cover it. Or alter your withholdings on your work study job so that you withhold more and aren't hit by such a big bill at the end.
If you're eligible for them, make sure to claim the American opportunity tax credit, making work pay credit, and the earned income credit.
posted by phoenixy at 5:46 AM on April 9, 2010
If you're eligible for them, make sure to claim the American opportunity tax credit, making work pay credit, and the earned income credit.
posted by phoenixy at 5:46 AM on April 9, 2010
What are some ways a student like me can get around having to pay such (relatively) high taxes?
At that income level, I'd expect that your federal tax liability is for self employment taxes and not for income taxes per se.
Note, the self employment tax rate (15.3%) is exactly the same as the sum of the employee (7.65%) and employer (7.65%) payroll taxes payed by (and behalf of) every employed person. Your tax rates are not relatively high.
Your consulting hourly (or job) rates need to include an equivalent amount corresponding to the employer (7.65%) portion of the self employment taxes to achieve parity with what you'd be paid as an ordinary employee (also, you should be submitting quarterly estimated tax payments).
posted by Consult The Oracle at 5:57 AM on April 9, 2010 [2 favorites]
At that income level, I'd expect that your federal tax liability is for self employment taxes and not for income taxes per se.
Note, the self employment tax rate (15.3%) is exactly the same as the sum of the employee (7.65%) and employer (7.65%) payroll taxes payed by (and behalf of) every employed person. Your tax rates are not relatively high.
Your consulting hourly (or job) rates need to include an equivalent amount corresponding to the employer (7.65%) portion of the self employment taxes to achieve parity with what you'd be paid as an ordinary employee (also, you should be submitting quarterly estimated tax payments).
posted by Consult The Oracle at 5:57 AM on April 9, 2010 [2 favorites]
If you're a consultant, you should be getting 1099 forms, not 1040s. If you're getting 1040s, then those companies should be doing withholding and all the other obligations of an employer.
Secondly, at your income level, as a student, with overhead costs, there is no way you should owe taxes. The only way you could possibly owe taxes is if you're using the EZ forms.
Turbo Tax Online has a free edition, that I believe the free version will handle a basic tax return with some exemptions. (I could be wrong about the exemption part though. ) Turbo Tax isn't the right solution for someone with complex tax issues who doesn't read bureaucrat-ese, but it's plenty robust enough for your situation, and I'm betting if you just plug in the numbers you have, and let the application do the voodoo it do, you'll find yourself with no tax liability.
I am not an accountant. I don't even own a green visor.
posted by dejah420 at 6:15 AM on April 9, 2010
Secondly, at your income level, as a student, with overhead costs, there is no way you should owe taxes. The only way you could possibly owe taxes is if you're using the EZ forms.
Turbo Tax Online has a free edition, that I believe the free version will handle a basic tax return with some exemptions. (I could be wrong about the exemption part though. ) Turbo Tax isn't the right solution for someone with complex tax issues who doesn't read bureaucrat-ese, but it's plenty robust enough for your situation, and I'm betting if you just plug in the numbers you have, and let the application do the voodoo it do, you'll find yourself with no tax liability.
I am not an accountant. I don't even own a green visor.
posted by dejah420 at 6:15 AM on April 9, 2010
This happened to me the first year I started doing significant freelancing. Imagine my surprise when I discovered I owed $1500 to the government in April.
The first thing I did was immediately change my withholding on my salaried job. Withhold a little bit extra each paycheck. Say you get paid every two weeks -- withholding just $20 each week will basically cover what you owe for the freelancing, and that's far less painful and easier to accommodate in your budget than writing one big check in April.
When I did owe the $1500 and I couldn't pay it all right away, I just called the IRS, explained that this was my first time with the freelancing and it caught me by surprise, and could I have an extension? They were extremely easy to work with, set me up with a payment plan with some very minimal interest, and I got it all paid off pretty quickly. I think if you do this frequently they get pissy, but if you explain it's your first time dealing with this, they should be very friendly.
I don't think you can get out of paying them at all; as others have said, this is what happens when you freelance. But you can deal with it for this year, and prep yourself for next year, and it should all be okay.
I am not a tax professional, this is just based on my experience, something something disclaimers.
posted by olinerd at 6:25 AM on April 9, 2010
The first thing I did was immediately change my withholding on my salaried job. Withhold a little bit extra each paycheck. Say you get paid every two weeks -- withholding just $20 each week will basically cover what you owe for the freelancing, and that's far less painful and easier to accommodate in your budget than writing one big check in April.
When I did owe the $1500 and I couldn't pay it all right away, I just called the IRS, explained that this was my first time with the freelancing and it caught me by surprise, and could I have an extension? They were extremely easy to work with, set me up with a payment plan with some very minimal interest, and I got it all paid off pretty quickly. I think if you do this frequently they get pissy, but if you explain it's your first time dealing with this, they should be very friendly.
I don't think you can get out of paying them at all; as others have said, this is what happens when you freelance. But you can deal with it for this year, and prep yourself for next year, and it should all be okay.
I am not a tax professional, this is just based on my experience, something something disclaimers.
posted by olinerd at 6:25 AM on April 9, 2010
You took the student loan interest deduction, right? (Hope I got the terminology right.)
Any you subtracted your business expenses from your consulting profit, right? You subtracted X% of your laptop and software costs, yes? (Where X% = how much you used it for work divided by how much you used it overall.) You looked carefully at whether your workspace qualifies as a home office, which would allow you to deduct some portion of rent, yes? Those books you bought that you consulted for your consulting work, you subtracted some percentage for them, right?
Also, I'm not sure that it's correct to not include scholarships. You might want to go to your school's help center to get some advice on all of this.
posted by salvia at 7:24 AM on April 9, 2010
Any you subtracted your business expenses from your consulting profit, right? You subtracted X% of your laptop and software costs, yes? (Where X% = how much you used it for work divided by how much you used it overall.) You looked carefully at whether your workspace qualifies as a home office, which would allow you to deduct some portion of rent, yes? Those books you bought that you consulted for your consulting work, you subtracted some percentage for them, right?
Also, I'm not sure that it's correct to not include scholarships. You might want to go to your school's help center to get some advice on all of this.
posted by salvia at 7:24 AM on April 9, 2010
dejah420: the 1040 is the form that everyone files. The 1099 is the form that contractors receive from clients, the counterpart to the W2.
I'm guessing, along with Consult the Oracle, that this 15% is self-employment tax. Not much way around that. $500 works out to about $45/mo. In the future, you'll need to need to bank that and file quarterly estimated taxes (1040-ES).
I realize this won't sound like helpful advice if you're having a hard time coming up with $500 to pay your taxes, but having a good tax guy (not necessarily an accountant) can save you many times more than you spend on his services.
posted by adamrice at 7:32 AM on April 9, 2010
I'm guessing, along with Consult the Oracle, that this 15% is self-employment tax. Not much way around that. $500 works out to about $45/mo. In the future, you'll need to need to bank that and file quarterly estimated taxes (1040-ES).
I realize this won't sound like helpful advice if you're having a hard time coming up with $500 to pay your taxes, but having a good tax guy (not necessarily an accountant) can save you many times more than you spend on his services.
posted by adamrice at 7:32 AM on April 9, 2010
The problem with consulting work is that I get hammered come tax time. The 1040s are unforgiving.
Time for some harsh talk; the 1040's are not unforgiving if you're at the 15% tax level. What is unforgiving is being in business for yourself and not at all understanding the process of, you know, being a business.
You need to contact the IRS and set up a payment schedule with them so that you can take the blow in small increments. Additionally, learn from your mistakes and, in addition to paying off your previous tax debt, start saving TODAY for your next tax season. If that means taking on more work, raising your rate, taking out a student loan or getting a part-time job, so be it, but don't blame the tax system because you were woefully unprepared.
posted by Hiker at 7:59 AM on April 9, 2010
Time for some harsh talk; the 1040's are not unforgiving if you're at the 15% tax level. What is unforgiving is being in business for yourself and not at all understanding the process of, you know, being a business.
You need to contact the IRS and set up a payment schedule with them so that you can take the blow in small increments. Additionally, learn from your mistakes and, in addition to paying off your previous tax debt, start saving TODAY for your next tax season. If that means taking on more work, raising your rate, taking out a student loan or getting a part-time job, so be it, but don't blame the tax system because you were woefully unprepared.
posted by Hiker at 7:59 AM on April 9, 2010
Seconding Hiker. Employees (through their employer's withholding) pay as they go (because that's what the federal income tax is, a pay as you go tax). You're not an employee, so you really should be making quarterly payments yourself to avoid the large bill due at the end of the year. Yes, 15% isn't a lot of money at all.
With a standarded deduction, you do not pay taxes on a significant amount of income. Assuming you're not a dependent (you talk about poverty line as though your income is the sole means to support yourself), that means you do not pay taxes at all on the first $5,700 you make.
According to Wikipedia (which isn't your accountant and neither am I for that matter)... for dependents, the standard deduction is equal to earned income (that is, compensation for services, such as wages, salaries, or tips) plus a certain amount ($300 in 2007). A dependent's standard deduction cannot be more than the basic standard deduction for non-dependents, or less than a certain minimum ($850 in 2007).
As Hiker said, part of being in business for yourself is understanding how to manage a business, including financially. You mention this poverty line, go on food stamps and see what other sorts of government assistance you can get. (Keep in mind, those of us taxes at 25-35% will be footing the bill.)
Complaining about income tax when it is due in April after you earned the money last year is like buying something in a store and getting mad at the clerk at the register when they charge you sales tax and you don't have enough to cover it. You're an adult with your own business, learn to plan ahead so you don't make this mistake again.
posted by Brian Puccio at 10:17 AM on April 9, 2010
With a standarded deduction, you do not pay taxes on a significant amount of income. Assuming you're not a dependent (you talk about poverty line as though your income is the sole means to support yourself), that means you do not pay taxes at all on the first $5,700 you make.
According to Wikipedia (which isn't your accountant and neither am I for that matter)... for dependents, the standard deduction is equal to earned income (that is, compensation for services, such as wages, salaries, or tips) plus a certain amount ($300 in 2007). A dependent's standard deduction cannot be more than the basic standard deduction for non-dependents, or less than a certain minimum ($850 in 2007).
As Hiker said, part of being in business for yourself is understanding how to manage a business, including financially. You mention this poverty line, go on food stamps and see what other sorts of government assistance you can get. (Keep in mind, those of us taxes at 25-35% will be footing the bill.)
Complaining about income tax when it is due in April after you earned the money last year is like buying something in a store and getting mad at the clerk at the register when they charge you sales tax and you don't have enough to cover it. You're an adult with your own business, learn to plan ahead so you don't make this mistake again.
posted by Brian Puccio at 10:17 AM on April 9, 2010
With that income you most certainly do not owe income taxes. However, you will owe Social Security and Medicare taxes of close to 15.3% on your net profit from your business. The key phrase is "net profit." You can reduce your net profit by deducting legitimate business expenses from your income. For example a computer or software that you needed to buy for your business, office furniture or any office supplies. You may also be able to deduct home office expenses, for example part of your rent and utilities, and car travel expenses to your job site. All of these reduce your self-employment taxes.
If you are at least 25 years old, you should look into the Earned Income Tax Credit that offsets the payroll tax.
If nothing else you should consider that you are earning credits to make you eligible for Social Security and Disability benefits.
Once you figure out what you owe, call the IRS and explain the situation. They will allow you to work out a payment plan. Do not fail to file, even if you don't have the money to pay. You can also file for an extension using Form 4868. This form takes literally 5 minutes to fill out and gives you 6 more months to file your return. You are supposed to send a check for your estimated taxes at the same time, but if you do not, the penalties are pretty mild, about 6% per year -- cheaper than a credit card. So even if you are 6 months late on $500 of taxes, it is only an extra $30.
I would recommend filing for the extension to take the heat off so you can figure things out. Then call the IRS next month and ask them to help you with a payment schedule. They are happy to help.
posted by JackFlash at 11:46 AM on April 9, 2010
If you are at least 25 years old, you should look into the Earned Income Tax Credit that offsets the payroll tax.
If nothing else you should consider that you are earning credits to make you eligible for Social Security and Disability benefits.
Once you figure out what you owe, call the IRS and explain the situation. They will allow you to work out a payment plan. Do not fail to file, even if you don't have the money to pay. You can also file for an extension using Form 4868. This form takes literally 5 minutes to fill out and gives you 6 more months to file your return. You are supposed to send a check for your estimated taxes at the same time, but if you do not, the penalties are pretty mild, about 6% per year -- cheaper than a credit card. So even if you are 6 months late on $500 of taxes, it is only an extra $30.
I would recommend filing for the extension to take the heat off so you can figure things out. Then call the IRS next month and ask them to help you with a payment schedule. They are happy to help.
posted by JackFlash at 11:46 AM on April 9, 2010
Nthing that you have to pay self-employment taxes, and nthing that one possible way to reduce those is to reduce your net profit by finding more tax-deductible business expenses to include on your Schedule C.
Do you quality for the Making Work Pay or the refundable American Opportunity Credit? Those are refundable credits and thus could be used towards paying your self-employment tax liability.
posted by Jacqueline at 1:31 PM on April 9, 2010
Do you quality for the Making Work Pay or the refundable American Opportunity Credit? Those are refundable credits and thus could be used towards paying your self-employment tax liability.
posted by Jacqueline at 1:31 PM on April 9, 2010
This thread is closed to new comments.
To me, this is not a tax problem but a budgeting problem. That's how I approach it for my freelance work, and it makes a big difference.
posted by peanut_mcgillicuty at 5:11 AM on April 9, 2010 [1 favorite]