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How Can Software Engineers Avoid Taxes On Their Side Business?

There is a well-kept secret among high earning professionals. Traditional high earners such as doctors and professors often have side businesses that not only generate extra income, but also serve as powerful vehicles for expense deductions, retirement savings and wealth transfer.

In the last decade, there has been a new wave of high earners: software engineers. Many of these young professionals make six figures and start side business to explore new ideas. Unfortunately, high earners with side jobs run into a frustrating reality: half their money goes to Uncle Sam.

If you are single and making $550,000 a year in New York city, your final dollar earned will be taxed a whopping 50.6%. That means if you make money through a side gig, each additional dollar will be taxed at this high rate. A small business that loses half of its income right off the bat is unlikely to survive. Here’s what you can do:

1. Start an LLC.

I will share the well-kept secret by professionals in the traditional high earning fields like doctors and professors: Set up an LLC! Make the side gigs into a business, a flexible and fluid business. Let’s take a step back. You have the employee mentality because you are, for the most part, an employee of a great tech company. The employer takes care of a lot of things for you: Paying a big portion of your medical insurance, matching your retirement contribution, providing wellness program, etc. Now, with this side business, you are RUNNING A BUSINESS! Yes, you are the employer now. So, get out of the employee mentality. Think from a business owner’s perspective: What is the cost of running this business?

Here is a series of questions for you. In order to work on your side business:

  • Do you designate a special room in your home?
  • Do you need to further your education?
  • Do you need to get better equipment or supplies (additional computers, monitors, etc)?
  • Do you need to get accounting software or hire an accountant to track your income and expense?
  • Do you need to travel?
  • Do you discuss business plans and ideas over meals?

The list goes on. You get the point, right? When you jump out of the employee mentality, you will feel so free. All these expenses incurred because you are trying to generate income, so they are all business deductions. You can go to B School if you want to grow your business, that is deductible. You all know how much that can be.

When you start a small business, you are likely to lose money. The beautiful thing is that with an LLC, these losses will move you to a lower tax bracket. Let’s go back to the example from earlier: you earn $550,000 and you just started an LLC that grossed $20,000 in the first year and incurred $40,000 in business expenses. This means you have a $20,000 loss. That loss will reduce your tax liability more than $10,000! That’s a big difference. It only takes 30 minutes to set up an LLC and turn your liability into an advantage.

2. Use Your Side Business to Max Out Your Retirement Contributions!

Let’s fast forward to a few years later. Your side business is growing nicely, and you now gross $200,000 with around $50,000 in business expenses. Your side business is finally profitable. Are there any other tricks to avoid paying the highest rate for the $150,000 profit? Absolutely.

The most common strategy is to set up a SEP IRA. You can defer up to 20% of your profits (30,000 in our example) into this retirement plan. You can also set up a solo 401K to defer $57,000. All this money in your retirement plan will magically multiply with time and compound interest. But that's a topic for another blog.

3. Hire Your Kids to Help With Your Business

When you get older and your side business is even more profitable, you can hire your kids to save on taxes. By employing your kids, you will move to a lower tax bracket, pass on your wealth, and teach your kids a strong work ethic. Your kids can also put their earned money away into a Roth IRA so they can become millionaires in their early 30s and learn important financial lessons in their life: Time is on your side if you start early!

Doctors and professors have done this for years. It’s time for the new class of high earners to take advantage of these tried and true tax strategies.

Consult A Tax Professional

If you have a side gig and are seeking tips & assistance to reduce your taxable income, you could contact us to request a free consultation session by clicking the button below. We serve clients across different states of the U.S. and would love to provide you with the help you need!

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About The Author

Justine Zhou

Justine Zhou is the CEO of Zhou Agency. She is also a senior CPA and extremely knowledgeable advisor with well-rounded expertise in tax, real estate investment and insurance services.

Justine believes in understanding clients’ needs first and providing tailored consultation to clients’ unique situation. She uses language that the audience can easily understand and is good at incorporating her expertise in both tax & real estate to help real estate investors achieve maximum tax savings.

JZHOU@ZHOUAGENCY.COM
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This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Zhou Agency assumes no liability for actions taken in reliance upon the information contained herein.