Tax Talk: Independent contractors and retirement plans

In this inaugural column, baltimoresun.com's tax experts answer your questions this filing season

March 03, 2004|By Todd Beamon | Todd Beamon,Baltimoresun.com Staff

Every Wednesday through April 21, baltimoresun.com's tax experts will answer your questions this tax-filing season.

Our experts are Jim Dupree of the Maryland office of the Internal Revenue Service in Baltimore and, this week, Gregory S. Horning of Stout, Causey & Horning in Hunt Valley.

To be included next week, please use the form at the right side of this page to submit your questions.

I am a full-time employee at a local company. I also am a real estate agent, which is considered an independent contractor. Last year, I did not make much money from real estate, but several fees and dues were paid along with training classes. Which items may I deduct?

Patricia, Catonsville

Dupree: Generally, Patricia, when an individual is self-employed as an independent contractor, all ordinary and necessary expenses they incur while doing business are deductible on Schedule C or Schedule C-EZ.

The only question could be whether you were conducting these real estate duties in a business-like manner. That is to say, were you truly in business intending to make a profit, but just had a bad year?

If you can answer yes, then business expenses and, therefore, a possible loss can be taken. If no, then you can save the expenses as start-up expenses and start to deduct them when you realize some income and operate in a business manner.

Another opinion, Horning: To deduct the expenses related to your real estate activities, Patricia, you must clear two hurdles.

First, you need to establish that you are engaged in a trade or business. If you are involved in real estate activities to generate a profit, your real estate activities will qualify as a trade or business.

Once you have determined that your activities qualify as a trade or business, you may deduct those expenses that are ordinary and necessary to carry on the business.

Necessary expenses are those that are appropriate and helpful to the trade or business. Ordinary expenses are those that are common and accepted in that particular trade or business.

Common expenses that are deductible as ordinary and necessary in the real estate business include, but are not limited to: advertising expenses, automobile expenses, travel expenses, dues to professional and public-service organizations, subscriptions for professional journals, telephone expenses and expenses for continuing professional education.

If you did not make much money from these activities last year, your expenses may be greater than the income that you generated. If this is the case, you may use the loss from your real estate activities to offset other taxable income. This is why it is important to establish that you have a trade or business.

If you cannot establish that you are intending to generate a profit, the activity could be deemed a hobby and you only would be able to deduct expenses to the extent that you have income.

I recently exchanged shares from one mutual fund to another and realized a $200 loss. This is an employer-sponsored 403(b) account. Can I use this loss to reduce my income level?

Marcela, Baltimore

Dupree: A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations and certain members of the clergy.

Such individual accounts can take one of these forms:

An annuity contract, which is provided through an insurance company.

A custodial account, which is an account invested in mutual funds.

A retirement income account set up for church employees. Generally, such accounts may invest in annuities or mutual funds.

Contributing to a 403(b) plan has three benefits:

You do not pay tax on allowable contributions in the year they are made. Tax is not paid on allowable contributions until withdrawals begin from the plan, usually after retirement. Allowable contributions to a 403(b) plan are excluded or deducted from your income.

Earnings and gains on amounts in the 403(b) account are not taxed until they are withdrawn.

You may be eligible to take a credit for elective deferrals contributed to your 403(b) account.

In this case, Marcela, you cannot use your $200 loss to reduce your income level.

Losses that occur within qualified pension plans do not reduce current income. After all, the money you contribute to the plan is not taxed, and when distributions are made, any losses just reduce the amount that can be distributed.

Another opinion, Horning: An employer-sponsored 403(b) account is considered a qualified retirement plan under the Internal Revenue Code. Other common qualified retirement plans include 401(k) and SIMPLE plans.

Qualified plans provide a powerful, tax-favored vehicle for individuals saving for retirement. Contributions to these plans are tax deductible, within limits. In addition, all earnings within the plan accrue on a tax-deferred basis. This tax-deferred compounding allows participants to accumulate the funds they need for their retirement more quickly than an account for which income is subject to tax annually.

The deductible contributions made to these plans are not taxed until they are withdrawn from the account, usually after retirement. Also, any income or loss generated within the account is not subject to tax.

Due to the tax-deferral feature of qualified plans, the income from investments in the plan is not factored into the taxpayer's income; so, realized losses cannot be used to reduce taxable income.

Therefore, the answer to your question, Marcela, is "no." You cannot use the loss on the trades in your 403(b) account as a deduction on your income tax return.

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