Frugaling my way out of debt
I’ve been a student of some sort nearly all my life. I never worried about ponying up extra funds for a tax payment until 2013. And honestly, when I created Frugaling, I had nearly $40,000 in debt from credit cards, a car loan, and student loans. There was no way the taxman would give me anything but a fat return.
Then, a financial miracle occurred. In the summer of 2013, I began to make thousands of dollars in affiliate/ad revenue from Frugaling. The money poured in, and I was giddy. Finally, I could begin paying off all the debt — in record time.
I dropped all of it into student loan debt, and paid off nearly everything (finished the rest in 2014). My nerves calmed, and I could suddenly see freedom and future. Cheesy, I know, but my loans had dampened my spirits. Suddenly, I was renewed.
Ugh, self-employment taxes
As this new influx of funds padded my wallet, I unfortunately realized that by the end of the year, the taxman would be knocking. All of these funds from Frugaling were coming in untaxed — no withholding. These are self-employment taxes. Ultimately, this income must be declared and taxed at a penalty rate to pay for social services (i.e., Medicare, Medicaid, and Social Security).
After calculating all the money made and entering the numbers into TurboTax, the hypothetical refund reversed to a payment. The government wanted about $1,000. I sat there dumbfounded for a moment. All these advertisements and campaigns suggested I would “Get the biggest refund ever.” Those pesky self-employment taxes obliterated my student status.
It was a lesson in the difference between income and net worth. That year I had made over $30,000 between graduate student work and the website. I had barely any savings and negative net worth. Yet, I was being penalized for making money that could pay off financial aid faster. To me, it seemed preposterous that I was being taxed at a higher rate for this side income — with no net worth.
I owe Uncle Sam how much?!
In 2014, I paid off my remaining debt and my net worth has been hovering at a few thousand dollars. My stress over debt is non-existent, and I feel better than ever about my financial situation. But I’m not done with the struggle to make wealth while in graduate school.
I made over $20,000 “on the side” for Frugaling/business-related self-employment (I no longer make that kind of money, as I removed credit card affiliate links for now). After inserting my income and expenses into TurboTax, a shiver went down my spine. The numbers catapulted up over $4,000.
I’m fortunate that I’ve been saving for this moment. My savings account has enough to cover it, but my net worth will be swept away come mid-April. It feels awful to work this hard to save, make, and write. I have no net worth, and yet the funds I made will be disappearing.
But instead of letting this payment dampen my mood, I am more focused than ever on writing for you all, staying frugal and minimal, and building some real savings.
Yeah, self-employment taxes are rough. The funny thing is if someone was withholding as you went along, you’d never notice! It just feels terrible to make big lump sum payments. (I had two year-long fellowships in graduate school, which weren’t subject to withholding, so I had to make big payments also — although not SE taxes because fellowships are not subject to those, though they ARE subject to the income tax — they’re a weird beast.)
That’s absolutely right! The big problem is that these funds to go through automatic withholding. Now, a lot of people say, “Make regular payments, quarterly, to the taxman.” This strategy sometimes can alleviate the shock at the end of the tax year. But frankly, I’d rather have access to the funds and then allocate at the end of the year. If you choose the latter option, as many commentators mentioned, one MUST save throughout the year.
Similar kind of surprise tax happened to me in uni since I was on full scholarship (family was poor), but everything used for non-tuition was taxable. That meant all the money flowing into room and board, or the extra I used to buy a computer or travel to/from school on the opposite coast, was taxable. So somehow I scrounged up a thousand or so through paid medical experiment and some savings I had going into school, but it was an unpleasant realization nonetheless.
Taylor,
This comment really speaks to part of the problem — economically — with paying for college. What happens is that whatever money you do make gets taxed heavily. But ultimately, it might be going into room and board payments (AT THE COLLEGE)!
When we think about giving youth opportunities for greater earning potential and a strong education, we must think about the tax advantages we can give them. Additionally, those who have great wealth and have achieved success should give more to provide for future generations.
Thanks for your comment,
Sam
$4,000 sounds incredibly painful after all your hard work. But I bet it’s much lower than you’d end up paying over here (in the UK), where you typically pay up to 33% (unless you can offset it against items purchased for business). Of course $4,000 against the $40,000 you owed when you began your journey pales by comparison so you should definitely give yourself a pat on the back 🙂
Sophie,
Thanks for your understanding. It is painful to have to fork over whatever net worth I’ve scrounged up, but that’s way better than having tens of thousands in debt lording over my head. At very least, I can feel happy that it comes from worth — not debt — to make this payment.
Sam
Yeah, Sam. I’m counting on a bigger year with my Seniors and I’ll have to “pony-up” as well…ugh and double-ugh! Great article. ML
Mark,
Way to go! Happy to hear you’ve done well with your own “side hustle.” Yeah, it’s a tough scenario and really dampens the spirits of many entrepreneurs.
Thanks for reading,
Sam
Did you form a LLC or similar?
Will,
I have not… I looked at some of the pros and cons, and decided that I would not have enough time to go through the process. From what I understand, the money would be held by the LLC, and then I could “pay” myself in doses. Right?
Anyways, thanks for the idea!
Sam
How deflating… Work your tail off to try to get ahead just to watch your earnings fly out the door. But good for you to start setting money aside from the beginning. Planning for the tax man helps to lessen the blow, but only by a little bit.
Mrs. Maroon,
Right you are. I definitely planned for this moment, but seeing it go is hard. Perhaps if my net worth were a bit higher… In this situation it takes me back down to around $0!
I’ll keep at it! Thanks for the support.
Sam
The fact that you were able to pay off that debt is your positive!! Focus on that and give Uncle Sam his ‘due’. I was just explaining to my 10 yr old last night that I didn’t want to enter this trip contest on the radio because I wouldn’t be able to afford the ‘luxury tax’ of winning. She couldn’t believe our govt would tax prizes. I had to explain they tax higher winnings,I think over $600, at a higher rate bcuz it is extra money. She was shocked!
But I am shocked that the posters above were taxed on monies related to school. Fellowships and work study support a student in college and should not be considered taxable work income. That sux.
Dawn,
Thanks for your comment and support around tax policy regarding higher education. There are a lot of students — some worse and some better — that are going through this process. It’s scary that the tax policies are not more favorable for those trying to “better themselves,” but this is the world we live in.
I’ll stay positive, though, because I was able to pay off a lot of debt in the process.
All the best,
Sam
Going forward consider setting aside the tax man’s share of each untaxed dollar in a separate account that you designate for paying taxes from. Don’t “count” it as being part of your net worth as it isn’t. You may find you have set aside more money than you need when you calculate your taxes and that can be your refund check or seed money for next years taxes. Over time you will get better at estimating exactly how much you need to reserve for taxes.
This is a great suggestion, and something I incorporated into my regular routine in 2013. I learned that lesson the hard way the first time. Nowadays, I save regularly and don’t spend any of it because it’s not really mine. Hah.
Ugh. I went through this exact same thing. The first time I got hit with self employment taxes wiped me out (on the plus side it finally made me figure out my money… something you’re wayy ahead at).
I find I’m way better now at deducting as soon as money comes in. Self-enforced withholding. As soon as I get a cheque, I stick 20% into a separate savings account just to cover the tax bill. Keeps me from having to deal with the stress at tax time, and usually ends up being more than I need… which means a little extra to throw at my debt, or long term savings.
Anyway… keep up the good fight. It sucks getting blindsided, but now that you know it will never surprise you again!
Self-enforced withholding. Well said! It’s dangerous, though, for many people that do not understand self-employment taxes. What I fear must happen to some individuals is that they spend the earned income thinking it’s theirs or desperate to get by… And then they get hit with a nasty result at the end of the year.
Yup, I was hit with a potential $3000 tax bill. Thankfully I have some tax deferral options because of the source of the income (rental), but I wasn’t impressed with my first play at Turbo Tax. I do agree that it might be worthwhile to set aside 25-30% of your self-employed income so that it doesn’t happen again.
Good for you, Alicia! Happy to hear you structured your tax obligations well. Always helps to have some flexibility. 🙂
Hi Sam – you want to make sure that part of what you are having to pay is not underpayment penalties for not remitting until the end of the year. Without running your exact numbers, I can’t tell you for sure, but you may be better off remitting quarterly for that reason alone. From reading your blog for a bit, I know you are not of the camp who thinks it is terrible to pay any taxes at all. It is a matter of timing and preparation and having the mindset that the money owed is never really yours to begin with 🙂 Best of luck!
This is exactly why it’s so important to limit expenses and keep saving for emergency fund, IRA, future purchases, etc… you never know when you’ll need to dish it out!
Good thing you saved it beforehand I assume this is how people get in trouble with the IRS by not saving. I guess the quarterly tax thing might be a better option doesn’t sound as bad to pay $1,000 every 3 months. Luckily (and unluckily I guess) I don’t make enough from my side job compared to my regular job for this to be a big problem at the moment. But here’s hoping!
My liability was $3,820 this year. Fortunately, I had exactly $20 more than that saved up for tax purposes.
Holy cow! That was a close one. Haha. Glad you had enough!
I’m always of the mind set that if I am paying lots of taxes, I must be doing well….
Well said! 🙂
Yeah, I hate 1099’s. I’m setting aside money each month now based on how much I get paid out the previous month.
I set aside about 30-ish% of my self-employment income to cover taxes and I don’t count the amount in my “tax savings account” in my net worth calculations as I know most, if not all, of it will be used to pay taxes after my accountant is finished up with them. They are a pain, but at least you know you made some good money to owe that much.