“Will the IRS find out” is the wrong question

Ben (00:06):

Welcome back to the Retirement Tax Podcast. I’m your humble host, as always, your humble co-host, Benjamin Brandt, joined as always by Steven Jarvis. How you doing, 

Steven?

Steven (00:14):

Ben, I’m doing really good. We made it through another tax filing deadline, and I’m excited to get back to podcasting.

Ben (00:19):

Oh, and we had so much fun at our recent webinar, didn’t we? 

Steven (00:22):

It’s always great to be able to do live events. I mean, I know that people probably assume that CPAs are giant nerds and don’t like making eye contact, but great news, I can’t make eye contact through a webinar anyway, so it’s a perfect format for me.

Ben (00:33):

Well, the giant nerd part that’s still, you know, to be decided. We’ll see. Although, you have a lot of cool Spartan race medals that I don’t have, so you’re a little bit cooler than I am, but, you know, context is everything. But if you have no idea what we’re talking about Steven and I had a fantastic webinar at the end of May, if you registered for the webinar and weren’t able to make it great news, check your email. We did do a recording and we’re gonna put those in your email inbox if you forgot to register, well, you have no idea what we’re talking about. More great news. We’re gonna do another version of that webinar in October, so you could probably register now, had an over two retirementtaxpodcast.com, and make sure you don’t miss it, because if you love the audio version of this show, you’re gonna love the interactive video version where you can see, you know, what we look like and all that good stuff. So if you’re not registered, definitely check that out Retirementtaxpodcast.com.

Steven (01:21):

Yeah, we’ll have to, on the webinar leading up to it, we can play everyone’s favorite game of which one of us is older because there’s never an offensive way to answer that, so that’s perfect.

Ben (01:31):

I don’t even know which one of us is, I don’t wanna spoil it. I think I know, but I won’t spoil it. Sometimes, I’m surprised though. Confident, sometimes I’m surprised. I know who can run faster.

Steven (01:39):

Well, Ben, let’s dive into some tax topics for today. Of course, that’s why everyone comes and listens to the least boring tax podcast they can find is to learn about taxes and hopefully to learn about how we can make sure we don’t get killed on taxes. So, coming outta tax filing season, there’s always, I always come out with huge lists of things that are top of mind for me, of things that I’m commonly seeing people misunderstand or that people just, there’s opportunities for, whether it’s saving on taxes or just making sure we do things right the first time. And I like to be able to share those. And even though this is Aaron in June and you’re thinking, Hey, the tax deadline was a month and a half ago, but when you’re working on several hundred returns a year, it takes a little while to get through the whole list.

Ben (02:22):

Well, and Steven, if you’re anything like me, which I know you’re not, but let’s pretend that you are. There’s no better time to reexamine your record keeping as right after taxes. So like on the run up to taxes, and I’m a professional financial advisor, right? I should probably have better records, but I’m always thinking about, now I know I gave some money to that charity, where did I put the receipt? Or some things are scrolled away in a manila envelope on my desk, and some things are saved in a Google drive. So right after taxes could potentially be a great way to reexamine your bookkeeping so that you can save yourself those gray hairs when the calendar inevitably rolls over to next year. So even though taxes are already done there’s always time to set new habits, better habits.

Steven (03:01):

Yeah. Ben, that wasn’t even on our list for today. That just reminded me of you know, some of our listeners may know I spend a lot of my time working with financial advisors, helping them do more with tax planning, and one of the things I was working recently with a group of advisors on is helping them to understand how they can make sure that the planning they’re doing with clients is getting reported on a tax return. So if you’re listening to the podcast, whether you do your own taxes or you do your own financial planning, or you work with a professional, one of the reminders I always give is that tax planning only counts if it gets reported to the IRS correctly. And unfortunately, it’s not always super intuitive to see on a tax return where some of these tax strategies that Ben and I will regularly talk about are actually coming through, whether that’s Roth conversions or QCD, some of these, you have to dig a little bit or make sure you really understand, okay, here’s what goes into this to make sure it really was reported correctly.

Ben (03:53):

Fantastic. 

Steven (03:54):

On the agenda for today, we wanted to talk about a recent experience that I had talking to some family members actually about let’s just lump it in under kind of that side hustle category, the 1099 income. This, well, a lot of us spend most of our careers getting a W2 and might be a little bit just different experience for us if we ever end up in a place where we’re getting this 1099 income. There was a lot of scrutiny around this last year as the IRS moved to change a rule around reporting activity through things like Venmo. We actually talked about the podcast earlier this year, and so that’s where some of the conversation came from, but it really got prompted, this particular conversation really got prompted by a comment a family member made about that basically implied that, well, if the IRS doesn’t know about it, it’s not taxable income. And that’s just not how this works.

Ben (04:47):

Well, gosh, yeah, if the IRS doesn’t know about it. So if you charge your neighbor $20 to cut their grass, you know, the IRS is probably not gonna ever know about that. But if you get a 1099, I think there’s a fairly good chance that the IRS has some knowledge of this transaction happening, right?

Steven (05:00):

Yeah, absolutely. If, it’s on a 1099s W2 s, any tax form you are getting, the IRS is also getting a copy of, and you make the comment about the neighbor mowing the lawn. I, yeah. Especially cash transactions. It’s gonna be a little bit hard for the IRS to really pin down whether that happened, but I really like to take to the approach, and Ben, I know you’re the same way that, I mean, we really need to do everything we can to pay the IRS the money we owe. We just don’t wanna leave a tip. We wanna make sure that we’re reporting accurately, that we’re reporting completely. We don’t want to put ourselves in a position where we’re at risk of the IRS coming and asking questions and finding things that we should have done differently. Because especially if the IRS can show that we intentionally didn’t report it, then we’re not only paying the taxes, we’re paying penalties, we’re paying interest, we’re creating just huge problems for ourselves. And as technology keeps evolving, the IRS is just gonna have more and more into our financial transactions, and it’s gonna become easier for them to see, wait, then you didn’t report this particular thing. 

Ben (06:04):

Well, that’s an excellent point. Yeah. So tax savings isn’t about, you know cutting corners or not reporting things. Tax savings is about being really intentional, especially in retirement when we have a lot more flexibility to do so tax savings is about being creative with how we take our income, you know, making sure we’re getting full credit for charitable giving or anything like that. So we always say on the podcast, pay what you no tip. Oftentimes I’ll tell my clients, you know, I don’t want our next meeting to be through plated glass, so let’s make sure we’re following all of the rules and not getting in any trouble because we both have a lot on the line when comes to that. So yeah, we want to pay what we owe. We don’t wanna hide anything, but we want to pay as little as we can legally, legally is the key word. Get away with.

Steven (06:43):

Yeah. And then that’s exactly where I sort the conversation as this came up with family recently that they’re basically talking about, well, hey, will the IRS notice? We don’t report it. It’s okay, let’s go the route of, we need to report our income, and then let’s go the route of understanding, okay, what are the deductions that we can take? Because again, for a lot of people who have spent the majority of their career in a W2 role, having 1099 income is gonna be a whole new world. And, it can be really confusing of, well, what can I deduct and what can’t I, what should I be on the lookout for? And Ben, I’d be curious your experience, but it seems like I work with more and more retirees who whether they’re proactively looking for it or just comes their way, are having these opportunities to do some kind of consulting or have these kind of more minor roles that kind of are helping them transition into retirement. It’s not their full employment, but it’s a stepping stone. And so I’m seeing more and more people have these questions of, well, what is deductible when I have 1099 income.

Ben (07:41):

That was popular, you know, when I first started my career 15 years ago, that was reasonably popular, but I would say in the last three years with the work from home revolution, it is fantastically popular from both ends, from the employer and, the employee end. Both people are wanting this more because you take your average 60 year old engineer they have this incredible wealth of knowledge that is not specifically tied to punching a clock like it might have been when they started their career in their, you know, middle twenties. So they have this tremendous asset for the company that’s not time bound anymore. It’s wisdom bound, so they can actually do all the retired things they wanna do, spend more time with the kids or grandkids travel invest in hobbies, things like that. But, from Zoom, from their kitchen table, from, you know, 8:00 AM to 10, they could actually keep, getting significant fulfillment by mentoring the next generation.

(08:30):

And maybe they do it for offset part of the cost of their health insurance before 65, or maybe they do a fresh extra travel cash, or maybe they just do it because they really want to believe their career better than they found it. And that doesn’t mean nine to five Monday through Friday anymore because of the magic of Zoom and because, you know, many of our clients are so well qualified, it’s 10 hours a week. In fact, I’m gonna probably outline this in the book that I’m writing. But we had a client that was traveling every week between, you know, two different big towns in the Midwest. And she said, I’m getting burnt out. I can’t do this anymore. And so she went to them with the leverage of her extreme experience, and now she works three months out of the year in from her RV in Florida. So she’s doing her ideal retirement living in the RV as long as there’s a good cell signal or wifi signal. But then, you know, the rest of the year she gets to do whatever she wants, but then still get fulfillment and income from her career. So the idea of 1099s in retirement, in this brave new world of work from home, we’re gonna see 10 times more 1099s in retirement than we have seen in the recent past. So this is a great time to be talking about this topic.

Steven (09:36):

Yeah, and there’s a lot of tax implications that come along with this, especially this is your first time being a 1099 employee. Probably one of the most painful things I see is people make this transition is not recognizing that now you’re subject to self-employment tax, which means you pay both sides of payroll tax. And so if you just look at what my marginal income tax rate is and use that to estimate how much you’re gonna owe at the end of the year, you’re gonna be off because now you’ve gotta pay both sides of your payroll tax. So that’s definitely a painful piece of it, just that recognition that now taxes are not withheld from your pay that you might need to make estimated payments that you certainly need to be setting funds aside. That can be another painful experience switching to 1099.

(10:19):

And then there’s a lot of confusion around what can be deducted. And so I’ve got a whole list here. We’ll through some of these, but Ben, you already mentioned that one of the reasons you see people maybe taking these kind of transition roles is to potentially pay for healthcare as they, or before they turn 65 or potentially even again, just continue supporting travel or other hobbies after 65. And healthcare is one of the first things I look for when someone has 1099 income to say, is that something we can deduct? Because actually, the way we get to adjust our income for health insurance makes this really advantageous when we’re self-employed. And so that can either be that we’re going to paying for insurance on our own, or even when we are on Medicare, if we are paying any premiums for Medicare for any of the supplements, those are all things that we can deduct against 1099 income. So that is one that I’m always looking for is if we have 1099 income, do we have health insurance that we can deduct against that.

Ben (11:17):

Excellent. Well, and another thing to think about would be what are some everyday items that we’re using now that we weren’t previously getting a deduction for when we were W2 employees that we can potentially now kind of flip the switch and get a deduction? So I’m seeing in your notes here that a cellphone would be a good first example to tackle how can I deduct my cellphone if I’m now getting 1099 income?

Steven (11:37):

Yeah, that’s a great framework for looking at that, Ben, what are everyday things that I just couldn’t deduct before that I’m using for work? So again, we wanna pay every dollar we owe, but not leave a tip. So this is not like Ben and I are not winking at each other in this recording. Like, this isn’t like you trying to read between the lines and deduct things that you shouldn’t be allowed to. There needs to be a business purpose for this, but if in the course of your work, which working virtually for most people, things like cell phone, internet, these are gonna be things that you need for work and that we can start now deducting against this 1099 income there for some areas of deductions. Like, we’ll change gears here for just a second.

(12:19):

Like vehicle expense is something that a lot of people bring up. Can I deduct my mileage? And, yes, you absolutely can. With things like mileage, the IRS has very prescriptive rules. So here’s the rate you get reimbursed per mile. You need to keep track of when you drove those miles where you drove them to. You need to have a log of some kind, and you need to report to the IRS what the vehicle you used was, but it’s very prescriptive. Here’s the mileage rate and here’s how much you can deduct for thing coming back to the cell phone and internet for things like that, it’s a little bit more vague of, okay, well how much do I deduct? Because great, I’m using my cell phone for work, but I’m also using it for personal things. So how do I find that balance?

(12:58):

And that can be a little bit more subjective, but we wanna make sure that we have a business, a rationale behind what we’re doing. So, right. If I use my cell phone once a year for my business, I’m probably not gonna deduct a hundred percent of it. But this, for me, this comes back to if the IRS ever were to come and ask me questions, I wanna be able to respond with a straight face and say, here’s what we were doing on the more aggressive end. We’ll, using the cell phone as an example, I definitely have worked with clients and I’ll support them in this approach of, well if I didn’t have a cell phone for work I wouldn’t be able to use it for personal purposes. And so really it’s because of work. I have the cell phone, so I’m gonna deduct the entire thing.

(13:42):

That might be a little bit more aggressive in approach, but you can see where the logic comes in there. So really we’re just, we’re looking for anything that you’re using in your business that could potentially offset that 1099 income. So we mentioned health insurance. We talked about things like cell phone and internet, your mileage as you’re driving. You can also deduct a home office. There’s some specific rules around what qualifies as a home office and what portions of your house you can use for that. But thankfully, there’s a simplified approach the IRS allows that’s based on square footage, that makes the math a lot easier, as opposed to having to track all the individual expenses that you incur during the year. Ben, you mentioned that this might come up for engineers, people with professional backgrounds with a particularly licensed skillset. So continuing education is another area where we can keep track of and deduct for against 1099 income. If there’s classes you need to go to, if there’s certifications you need to maintain to be able to continue doing the work that you’re doing to generate that 1099 income, those are all absolutely deductible. 

Ben (14:49):

So after we organize know things that we’re already using post-retirement, that we weren’t getting a deduction for pre-retirement we can probably start to layer additional things on, like we, now that we are earning money through a 1099, where could we potentially invest where we were similar to what we were investing while we were working? So one idea would be like a solo 401k. So, I forget what the logistics are, as long as you don’t have employees, you can do a solo 401k, potentially even a Roth 401k where you can start to, whether you want the deduction or not continue to save money just like you were when you were a W2 employee, now that you are a 1099 employee. So that would be recreating or creating again, a deduction we weren’t getting prior, or at least through a different method of savings. So that’s 401k also our tax prep and filing fees. Steven, I think you probably know a thing or two about that.

Steven (15:36):

Yeah, so I’ve got both tax prep fees and financial planning fees on here because when we’re just filing a 1040 in a given year, those aren’t things that we get a tax benefit for. But again, if we have 1099 income that this gets reported to the IRS as self-employment income as business income. And so now we can start looking at things that wouldn’t otherwise be deductible. So a portion of our tax prep fee, and I say a portion because you’re still having a 1040 prepared, you’re still having some of your individual taxes looked at. So we can’t just deduct all of it, but a portion of our tax prep fees, if you work with a financial advisor and your financial advisor is helping you set up that solar 401k is giving you recommendations on expenses that you can deduct, helping you understand how to navigate that, then great.

(16:21):

Now a portion of that financial planning fee, we could make an argument for deducting against your 1099 income as well. Then the other one that we can have a little bit of fun with, if we’re intentional about how we plan things is now we can start deducting some of our travel costs against that 1099 income as well. This is definitely an area where, again, we wanna make sure there is a business rationale for this. We can’t just constantly fly our whole family to Hawaii and you know, deduct everyone’s plane tickets against our 1099 income when most of has nothing to do with work. But the way, Ben, you mentioned earlier that I have all these spartan medals, anytime I’m traveling for work, I will intentionally look for races in that area that I can potentially do because now I’ve flown somewhere for work. I’ve got at least some of my nights of a hotel, I’ve got some of my rental expense, my rental car expense. I’ve got some of these different things that I’m doing for work anyways, and they all are tax deductible. And then I’m not deducting my race fee. But now I’ve done a personal trip to go do a race that’s mostly tax deductible.

Ben (17:29):

I’ve done something very similar. I like to go to indie music shows and yeah, that’s the first thing I do is I jump on the internet and say, okay, I’m gonna be in Orlando in two months. Are there any bands that I like that are playing in or, you know, some more in Orlando. So I’ve been able to see some amazing shows and because I have legitimate business travel, of course, like you say, you can’t write after your Spartan ticket, but I, and I’m not gonna write off, you know, the Uber to the concert or the you know, the drinks that I have at the concert or the concert ticket itself. But if you can sort of, kind of marry these items together in a legitimate way yeah, you’ll be able to to deduct the travel expenses. 

Steven (18:07):

So I guess Ben, for a lot of our listeners, really the point of this conversation is that if you end up with 1099 income, it’s worth taking a step back and thinking proactively about these things. You don’t need to spend days and weeks and months coming up with this really involved strategy of how you’re going to track all these expenses, but you just wanna make sure you’re thinking through, okay, are these things relevant? Do I need to keep some receipts? Do I need to log some miles? Do I make sure that when I get to tax time, I’ve got the information I need to not tip the IRS when it comes to my 1099 income?

Ben (18:38):

Excellent. Any parting thoughts, Steven?

Steven (18:40):

Ben, like with any other area of tax? We’re gonna come out ahead if we’re intentional. That’s really what it comes down to is take that little bit of extra time, listen to a podcast maybe from a couple of guys who aren’t as boring as everyone else on taxes, whatever it’s gonna be. But when we’re intentional, when we think ahead, that’s when we can make sure that we’re not getting killed by the IRS.

Ben (18:58):

Well, speaking of which, thank you so much to everybody for tuning into the least boring tax podcast. We always appreciate it. And until next time, don’t let the taxmen hit you where the good Lord split you.

Steven (Disclaimer) (19:09):

Hi everyone. Quick reminder before you go. While Ben and I feel very strongly about the information we’re sharing on this podcast, it is for educational purposes only and should not be taken as specific tax, investment or legal advice. You need to make sure that you are working with a professional to evaluate how these concepts apply to your specific situation before you take action.