How do I handle 10-99 future tax money if I'm in debt?

[iseethruyou]

Resident here:

My wife recently started doing some freelance work and bringing in what may amount to $60k in 10-99 income. We have about $33k consumer, auto, and her student loan debt. The consumer debt ranges in interest from 10% - 25% APR. I know that I'll owe taxes on the 10-99 income in April 2019, and that the prudent thing would be to set aside enough to pay that now, but I'm struggling with the prospect of sitting with 15k in my business account while paying less to offset the high-interest credit card and auto loan debt.

Should I pay down the debt aggressively now, hoping that the income stream is sufficient to save aggressively and make up the difference by April next year, or do I play it safe and hold the money in savings?

 

Thanks!

[jfoxcpacfp]

Pay down the high-interest debt and save the rest for taxes and an emergency fund. Hard to say how much you'll need for taxes since you're a resident and I don't have the full picture, but about 1/3 of her earnings, or $20k for state and fed and, hopefully, that will be more than enough.

[TotallyBroke]

It is a much worse situation to owe the IRS money than consumer debt.  Even Dave Ramsey recommends paying the IRS before anyone else on a debt snowball.  Either way, if you don't pay the debts, your credit will be destroyed.  However, there are bigger legal implications to not paying the federal government than not paying a credit card company.

Since I am still employed, but also had side gig 1099 income, here is what I do.  I look at last years tax return and calculate my effective tax rate (Total gross money I made/Total taxes paid which includes SS/Medicare/Income/State).  In 2016 it was 19.6%.  Just finished my 2017 taxes and it was 22.7%.  I have lower interest debt than you have (student loans and mortgage), so I feel a little more comfortable setting aside 25% of all gross 1099 income in a "High Yield" savings account at Ally.  I'm saving a little more than my effective tax rate because I expect to make more money this year.

It seems like you think the money in that account is still yours until you give it to the IRS.  I do not.  All money in the "Taxes" portion of my savings account is considered to be IRS money (as if it was already withheld from my paycheck).  I don't even count it as I calculate my net worth each month.  I just get the benefit of making a little interest on the government's money until I have to give it to them.  They did the same for me for many years (until I realized getting a huge refund isn't a good thing).  When taxes are due (quarterly), the money is there for me to give to the IRS and my monthly budget is unaffected.

Now, imagine that you have $15K in a savings account for taxes, but when you file taxes, you only owe $12K.  Guess what? You just got a $3K "refund"!  But, you made interest on that money instead of the government.  Then, you can take that "tax refund" which was never given to the government and use it to pay down that high interest debt.

Bottom line: think of money you set aside for taxes into that savings account as payroll withholding.

[The White Coat Investor]

iseethruyou wrote:

Resident here:

My wife recently started doing some freelance work and bringing in what may amount to $60k in 10-99 income. We have about $33k consumer, auto, and her student loan debt. The consumer debt ranges in interest from 10% – 25% APR. I know that I’ll owe taxes on the 10-99 income in April 2019, and that the prudent thing would be to set aside enough to pay that now, but I’m struggling with the prospect of sitting with 15k in my business account while paying less to offset the high-interest credit card and auto loan debt.

Should I pay down the debt aggressively now, hoping that the income stream is sufficient to save aggressively and make up the difference by April next year, or do I play it safe and hold the money in savings?

 

Thanks!

Click to expand...

It's a dice roll for sure. I know people who paid off the student loans using their tax money and then managed to save up the taxes again prior to April 15th. You can save a lot of interest that way, but I can tell you this- the IRS is not someone you want to owe money to.

[adventure]

iseethruyou wrote:

Should I pay down the debt aggressively now,

Click to expand...

Uhhhh, yes, at least the consumer debt. You have 14 months until the taxes are due (on money you haven't even earned yet!!), so how much do you think you'll owe?

60k as a resident, 60 1099, ~25% tax rate (high, I'd think) = 30k in taxes / 14 = 2100/month. How much is being withheld from your paycheck now? Seems like you could withhold more - once you actually make the money. Or just pay quarterly. Still seems like a future thing to worry about later, once you actually start earning money.

Until then, I can't see how you come out ahead paying 10-24% interest. I can't even see how that's better than oweing $ to the IRS at "½ of 1 percent" - wrt the other posters here, 24% > 0.5%.

[Sneezy]

How reliable is the outside income?

If it is 100% stable I think you could use the first 33K to pay down the debt starting with the highest interest rate and then the rest on taxes

If less certain I'd reserve 1/4 for taxes figuring you can make up any difference nearer the end

 

I make a similar amount of 1099 income annually and send in estimated taxes haphazardly during the year to approximate my liability.  I don't worry too much about it but have the advantage of getting a "bonus" near the end of the calendar year and a taxable account I could use if needed