Even financial bloggers don’t always get everything right.
This year I found out there is a dark side to earning a decent amount of passive income. While making money outside your job is absolutely great, you have to remember that at some point you have to report it all to the IRS. And that means paying a whole lot of extra income taxes!
While the concept of having to paying taxes on your earnings is no secret to anyone, the way you have to go about it is a little bit more complicated than simply waiting until February and then paying in a thousand bucks one time. In fact because of the mistakes I made, I’ll likely have to pay a penalty for my negligence.
If you’re someone who freelances or makes a decent amount of extra income (perhaps from blogging or some other activity on the side), then listen up! Don’t make the same errors I did and help yourself avoid the headache.
What Did I Do Wrong?
2014 was a GREAT year for my passive income generation efforts.
- My retirement funds were maxed
- My investments grew.
- I received dividend payments every month.
- Best of all: Blogging income was phenomenal – more than ever before!
All the right kinds of things you’d WANT to hear, right?
Of course. But there’s a flip side to all of that.
You see in the past whenever I made any extra income on the side, there was never an issue when it came to my taxes. My withholding I had already paid on my employment income was so large that the extra taxes I owed on my side income would simply offset them by some small amount (since they were pale in comparison). For example: If I was usually expecting a tax refund of around $4,000, perhaps I’d only receive $3,000 instead.
Up until last year this was never an issue. Then in 2013 something new happened – I actually had to PAY IN a tax payment as opposed to receiving a refund check. Though it was awesome and all to have made so much side income that year, I was realizing that I was entering into uncharted territory (for myself) when it came to business / self-employment taxes.
Then last month things got even heavier …
What I Should Have Done for My Extra Income Taxes:
Recently as I was adding up the figures of my blog income records, I realized something: I had actually earned about twice as much money as I did last year!
Combine that the larger volume of capital gains and dividends we had received and I became suspicious that I was going to owe a lot more in taxes than last year.
That’s a big problem. And here’s why:
The IRS expects that when you earn a significant portion of income that isn’t withheld right away (like the way they do with your paycheck) that you’ll make regular quarterly estimated tax payments to them.
Even though these estimated quarterly payment amounts can be based on a lot of different factors, the way I should have approached this was to estimate my total side income for the year and then make quarterly payments on them throughout the year.
Who knew doubling your revenue would come with such a headache!
As it turns out, the IRS doesn’t take kindly to waiting a whole year to pay them the money you owe. And so if you fail to do so, there will be penalties to pay!
Darn! Penalties are the worst. It’s basically just throwing your money away due to ignorance.
Could there be any redemption? I decided with only 4 weeks left as 2014 was coming to a close, it was time to get down and dirty and crunch some numbers. I fired up Microsoft Excel and started estimating the extra income taxes I’d likely owe this year. As it turns out, they were a lot! I came up with a figure close to $10,000!
It Pays to Work with a Professional:
As I found out last year when I needed some help with my SEP IRA, seeking the advice of a tax professional is well worth the cost. Not only can they give you piece of mind that you’re finally doing things correctly, but they can also help educate you on things you could do differently to help save even more money in the future years.
After going back and forth with my advisor, his estimates came in closer to us owing $6,000 as opposed to the $10K I initially thought I we did. Together we worked out a modest figure for how much I should pay now before the last tax quarter ended.
It turns out my penalty won’t really be too bad (less than $100). At our next meeting we’re going to discuss a few strategies for how I can avoid tax penalties in the future as a result of the money I’m making on the side.
How You Can Get Your Taxes Right:
If you make any significant income or even planning to (whether it be from your blog or whatever), then you need to do the following:
- Work with a tax professional. Again, don’t be penny wise and pound foolish. When it comes to navigating your taxes and knowing the rules, seek the advice of someone who knows what they are doing. Its fine and all to ask questions and try to understand things for yourself. But don’t do open-heart surgery on yourself. Get the right kind of help.
- Be realistic about your extra income. My big blunder here was that I didn’t anticipate making so much blogging income in 2014. Although the extra revenue was great, I should have been better prepared to handle the tax end of the earnings. In 2015 my tax preparer and I are going to work a quarterly income tax payment schedule that I will pay in to avoid penalties and end of the year shock.
- Budget your tax payments. Another big disaster on my part was not to budget for the taxes I knew I would eventually have to pay in. No matter what my tax pay-in ended up being, I should have been ready to handle it. Going forward I’m going to have a rule about saving a minimum of 25% of my blogging income simply to cover the quarterly taxes I will owe.
- Contribute to a SEP IRA. What would you rather do – give your money to the IRS or invest it for retirement? Hard choice, right? Last year I discovered that as my own employer I was able to contribute 25% of my profits to a SEP IRA which ultimately ended up saving me about $500 in taxes. This is where working with a tax professional can be valuable. Together the two of you can discuss strategies such as this and avoid mistakes like I made with my extra income taxes.
Readers – How many of you make quarterly income tax payments? Has anyone else ever found out the hard way about penalties (like I did)?
Image courtesy of Flickr | Ken Teegardin