Earned Income: The Bane of the Graduate Student’s Roth IRA

 

 

This is my contribution to The Roth IRA Movement started by Jeff Rose at Good Financial Cents.  The post will briefly touch on the advantages of the Roth IRA account but will focus on how graduate students can determine whether or not they have earned income.  For more posts with greater detail on various aspects of the Roth IRA, please visit the Movement’s page.  Also, I am not a CPA or financial advisor, so please do your own research and consult with a professional!

 

Having, I’m sure, motivated you that saving for retirement while in graduate school is both beneficial and necessary, I’ll return to the recommendation I made at the end of the second post – the Roth IRA.  First I’ll tell you why the Roth IRA is a great choice and then I’ll show you what I dug up concerning earned income, which is necessary to contribute to an IRA but that you may or may not have as a graduate student.

 

 

Why Should I Tie My Money Up in a Tax-Advantaged Account?

 

I’m going to assume that your retirement savings are actually meant for retirement, meaning you intend to not withdraw any money from them for several decades.  You should have a separate emergency fund and savings for shorter-term goals like a house down payment.  In that case, the government has given us amazing options to get out of paying taxes while our money is compounding with special tax-advantaged accounts

 

If you keep your retirement savings in a non-tax-advantaged account, you have to pay tax on your earnings every single year, like you do with a regular interest-bearing checking or savings account.  If you think back to our compound interest example, you know that a small tweak in your rate of return can have massive implications after decades of compounding.  Instead of earning a 10% rate of return, for instance, after taxes you will only have a (100 – tax rate)*10% rate of return.  Right now I’m in the 15% federal tax bracket and 6% state, so I would only get a 7.9% return if my returns were taxed.

 

What can this mean over the long term?  Let’s continue with our example of Jamie from my previous post (using the same calculator).  For simplicity, let’s say Jamie has $16,000 at the end of her PhD that she invests in a tax-advantaged or non-tax advantaged account.  She’s in the 25% federal tax bracket and pays 6% in state taxes as well.  How will her money grow in each of these accounts over the 38 years until she retires?

 

 

No-brainer, right?  Go for the tax-advantaged account!

 

 

What Kind of Tax Advantaged Account Should I Use?

 

As a graduate student you don’t have access to your university’s 401(k) or equivalent, so assuming you don’t have any other employers (including yourself), you are limited to IRAs for tax-advantaged retirement accounts.  There are two types of IRAs available: traditional and Roth.

 

The major difference between the traditional and Roth IRAs is when the money is taxed.  It’s true that the contributed money grows tax-free, but you will be taxed when you put it in or when you take it out.  With a traditional IRA, you contribute money pre-tax and the withdrawals from the account are taxed.  With a Roth IRA, you contribute money post-tax and the withdrawals are tax-free.  So the first thing you have to ask yourself is: will your tax rate in retirement be higher or lower than it is now?  You have to weigh your current income against your retirement income as well a guess whether overall tax rates will increase or decrease.  For graduate students, the answer is almost certainly that our tax rates are lower now than they will be in retirement – at least, we all expect to be making lots more money post-graduation!  So the Roth IRA is likely the better choice.

 

Briefly, there are some other features of the Roth IRA worth knowing about (for more detail, visit The Roth IRA Movement):

  • You may only contribute earned income (more on this next) up to $5,000 per year (if under age 50).
  • There are income limits for contributing the full $5,000 – your modified AGI must be less than $107,000 for singles and $169,000 for married filing jointly (no problem!).
  • You can begin removing money from the account at age 59.5.
  • Removing money early will result in taxes and penalties unless it is a qualified distribution, such as in the cases of death, disability, or buying a first home (up to $10,000).

 

 

What the Heck is Earned Income?

 

Note: What I’m about to cover is not well-understood among graduate students and there are many different opinions.  I have talked with several administrators at my university about this issue and have called the IRS hotline a few times but still have not found a totally satisfactory explanation of the situation, especially from the IRS.  You may not like what I conclude, and honestly I don’t like it either.  If you disagree with what I’ve written or find it inaccurate in any way, please comment and I will look into your objections.

 

Roth IRA (and traditional IRA) contributions must be “earned income.”

 

“Earned income includes all the taxable income and wages you get from working. There are two ways to get earned income: You work for someone who pays you or you work in a business you own or run.” (source)

 

Basically, the IRS is trying to prevent people who don’t have any incomes other than interest and dividends, child support, unemployment benefits, etc. from participating in and benefitting from tax-advantaged accounts.  You have to work for the money that you contribute!  But of course we do work for our universities, and they pay us – right?  Not so fast…

 

Unfortunately, and crazily, for graduate students, we can get caught up in this definition of non-work as well.  Many graduate students are paid by fellowships – in fact, it is prestigious to be paid by a fellowship.

 

“Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.” (IRS Publication 590 p. 7)

 

So if you are paid by a fellowship during the year and you receive something other than a W-2 at tax time (like a 1099-MISC), that pay does not count as earned income.  If you receive a W-2, no matter if the source is a fellowship or a grant or something else, that is earned income.

 

Here is the really crazy part, from the instructions for the 1099-MISC:

 

“Do not use Form 1099-MISC to report scholarship or fellowship grants. Scholarship or fellowship grants that are taxable to the recipient because they are paid for teaching, research, or other services as a condition for receiving the grant are considered wages and must be reported on Form W-2. Other taxable scholarship or fellowship payments (to a degree or nondegree candidate) do not have to be reported by you to the IRS on any form.”

 

That means if you are paid by a 1099-MISC, your university is not paying you for any services such as teaching or research.  There are not supposed to be any conditions requiring you to work for that money!

 

That is ludicrous and insulting.  Of course we have to work to pursue our graduate degrees.  We do research, we take classes, we teach.  A PhD student woudn’t be retained by his program if he didn’t do the work expected of him, no matter how he was paid.  We have the same jobs whether we receive 1099-MISCs or W-2s.

 

So perhaps there is a glimmer of hope for those receiving 1099-MISCs.  Although I doubt your university’s very sophisticated tax professionals made a mistake, you could at least inquire at payroll as to why you received a 1099-MISC instead of a W-2.  Perhaps (slim-to-nil, I imagine) there are conditions on your fellowship that you work and they should have given you a W-2 instead and you will be able to contribute to a Roth IRA.

 

In summary, here is how the way you are paid relates to your ability to contribute to a Roth IRA:

 

 

 

Remember that if, in a calendar year, you receive any earned income, you can contribute up to that amount to a Roth IRA.  For instance, if the bulk of your pay comes in the form of a 1099-MISC but during one semester you were paid with a W-2 for teaching, you can contribute to a Roth IRA in that year, up to $5,000 or the amount you were paid on the W-2, whichever is less.

 

In my next post I will suggest ways that graduate students being paid with 1099-MISCs can save for the future despite their lack of earned income.

 

In summary:

 

  1. Tax-advantaged retirement accounts can make your contributions grow super fast.
  2. Roth IRAs are great vehicles for graduate students with earned income.
  3. If you are paid by a W-2, you have earned income.

 

Did this post inspire you to contribute to a Roth IRA?  What do you think about the earned income debate for fellowships?

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78 Responses to "Earned Income: The Bane of the Graduate Student’s Roth IRA"

  1. WorkSaveLive says:

    I love your dry erase board! That is a nifty idea.

    I also love the Roth IRA. It’s suuuuuuuuuch a great vehicle to invest for retirement!
    WorkSaveLive recently posted..My Not-So-Secret Love Affair. Why the Roth IRA Makes My Heart Skip a Beat.

  2. Jessica says:

    Wow, I didn’t know how confusing the earned income issue could be. Thanks for bringing this issue up

  3. AverageJoe says:

    Nice work for someone who isn’t a CPA (at least I think you aren’t!).

    My favorite part of the post? “Sucks to be you.” I can’t tell you how many times I would have liked to have written that on a dry erase board….
    AverageJoe recently posted..The Roth IRA – Like Ice Cream, But in the Tax World

    1. Emily says:

      Um, no, not a CPA. Probably should put that in the post somewhere…

      I’m glad you liked it! I was pretty PO’d while researching this!

  4. Okay but what about those of us (me) who have Traditional IRAs? Do I roll everything over to a Roth? Do I open a Roth in addition to the traditional, even though I’ll probably just barely max out the traditional?
    Frugal Portland recently posted..Pinterest and Frugal DIY: Hand soap

    1. Emily says:

      Why are you dissatisfied with your traditional IRA? If you want to convert it to a Roth there is a procedure for that – I don’t know the details but you basically just pay the income taxes you would have owed on what you contributed. So that’s an option, or just leaving it in the traditional IRA. As for opening a Roth IRA as well, you can only contribute up to $5,000 per year between the two accounts combined.

      A lot of the reason people are so gung ho about the Roth IRA is because they already have 401(k)s so they have some taxable income for retirement and want to mix it up with non-taxable income. What’s your overall situation?

  5. I never realized how complicated the phrase “earned income” really is! Great explanation.
    Young Professional Finances recently posted..Roth IRA: My Meager Savings

  6. I’ve been wary of Roth IRAs lately. It seems that there is more than a fair chance income tax structures will reduce in the near future. There also seems to be a large interest in other tax revenues other than income taxes.

    No one can predict the future, but I have doubts we’ll be paying as much in income taxes in the decades to come. Maybe it’ll be a carbon tax, VAT or national sales tax.
    Wayne @ Young Family Finance recently posted..Managing Your Finances Takes Time

    1. Emily says:

      You make a good point. I definitely think we’ll be paying more taxes in the future but perhaps they won’t be in the form of income taxes alone. Personally I’m still confident that I’m paying a low enough rate now to favor the Roth, but for people who are not confident I guess the best strategy is to have both pre-tax and post-tax accounts to hedge.

  7. Hah! You were right, yours became a rant, too! The interesting thing is, we both want our Roths, but the IRS is our problem. Ack!
    Nell @ Housewife Empire recently posted..You Can’t Fund a Roth IRA without a Joint – Dirty Secrets of the Marriage Tax Penalty

  8. Heather says:

    I’m curious how/why a universities decide to use the MISC-1099 vs W-2. Is there some incentive for them to use one over the other? Or is one required based on where the fellowship/stipend/salary comes from?

    We haven’t moved the $ yet, but this post did remind me that we need to make N’s 2011 contribution to his Roth IRA before April 15th. Thanks!

    1. Emily says:

      I have an email in to someone at my university that will hopefully answer your first question. I would imagine it has something to do with getting out of paying the employer’s side of Social Security and Medicare. In my limited investigation so far the administrators have told me if you’re on a fellowship you get a 1099-MISC, if you’re on your advisor’s grant you get a W-2. They have not yet mentioned this fellowship-in-exchange-for-services option that should go on the W-2. It might be a unicorn.

  9. I’m not a graduate student, but I’m sure those who are will appreciate the thorough explanation you provided. If graduate students are indeed working for their money, and they receive a 1099, they should speak with someone at the university about issuing them a W-2. The fact that the university screwed up shouldn’t change the nature of the income. If it’s earned it’s earned.

    I remember trying to open an IRA with Washington Mutual during my freshman year of college. At the time, the minimum was $1,000. Yeah. That was way too much money to tie up for a struggling college student. Although, now I wish I’d found a way to come up with the cash. Nowadays, there are so many options. You can open an IRA with very little money.
    Shawanda @ You Have More Than You Think recently posted..What Not to Do When You’re Addicted to Debt

    1. Emily says:

      My developing understanding (though I’m still looking into it) of the justification of paying us with not-”earned income” is that the requirement is that we work (do research, etc.) to stay in the program but not explicitly for the fellowship money. Like, if you did no work they would kick you out of the program maybe at then end of the year? But it’s strange because when people are on fellowships and they take a leave of absence I believe their pay ceases for that time.

      I agree that $1,000 is a high minimum. When I opened my IRA several years ago Fidelity had an account option of a monthly transfer of $50 or $100 but didn’t need a minimum balance. When I looked again for my sister a couple months ago, that option was no longer there and the minimum monthlys were about $200, which was too much for her. She decided to aggressively pay down debt and then save up the $3,000 needed to open a Vanguard IRA. While I hope she sticks to that plan, I think her savings would have been much more certain if she had been able to open the account right away.

      1. Brad says:

        This just kills me – absolutely kills me! I worked like crazy to be able to get my university’s presidential graduate fellowship and was receiving my stipend through that method for a year. I then applied for and received, after a LOT of hard work – an extremely competitive national fellowship from the department of defense (NDSEG). My stipend increased and I thought everything was great with the world.

        However, I thought it was weird that the EITC and child tax credits didn’t seem to add anything to my federal return for 2010 even though that was the year we had our first child. I just assumed everything was right in the tax software and didn’t look into it. My wife and I had a second child in 2012 and while starting to file taxes for 2012 the total credit back was even less than in 2010 and 2011! With our current income we should be eligible for a hefty EITC as well as $1000 per child in alternative child credits. BUT these credits are all based on the amount of my “earned income.” If my wages were simply on a W-2 form then our refund for this year would be about $5,000.

        So from the tax years 2010 – 2012 my wife and I will have missed out on about $10,000 – $12,000 in tax credits because our income came on a 1099-MISC form instead of a W-2 form! I feel like smashing my keyboard while typing this. These fellowships were developed to award exceptional academic candidates who EARNED them, but in the end I get payed just as much or sometimes less than my peers who didn’t get the fellowships and who are doing the exact same kind of WORK that I am.

        I brought this up multiple times with the Department of Defense and I only get the answer that they are sorry for the “inconvenience” and that that is just the way it is in their contract. They have to send the funds straight to me and can’t set up a negotiation with my university to have them pay me the exact same money through a W-2.

        Who wrote this law, and where is the common sense? My peers in the same department are “earning” their income doing the exact same work that I am!

        Seriously, I better stop before I smash my keyboard.

        1. Emily says:

          Brad, I don’t know how to respond to you except to say that I’m sorry that you lost out on those tax credits due to the ridiculous tax arrangement between the universities and the federal government. I know you must be highly qualified to receive an NDSEG and it isn’t fair that your income is different from that of your labmates and classmates. I hope that the stipend increase makes up for the loss of the tax credits or at least that having those fellowships will boost your resume enough that you will get other funding or jobs that will make up for the loss of earned income over these years. I’m not surprised that the DoD was inflexible on this issue. Thank you for alerting me to your circumstances regarding these tax credits – it’s probably unusual for a student receiving unearned income to be married with two children, but that doesn’t mean that you shouldn’t receive the credits that other parents do (in a reasonable tax arrangement). How does the amount of your wife’s income play into being eligible for these credits – will earning more qualify you two?

  10. I’ve hoping to get some work study in grad school.. and my recollection (hopefully I’m right)is that that’s W-2 income. Fingers crossed. I still want to max out my Roth IRA for 2013 if there’s any possible way.
    Well Heeled Blog recently posted..High Prices in Fashion Magazines

    1. Emily says:

      When I did work-study in college I was paid with a W-2. And there’s “work” in “work-study” after all – they are explicitly paying you for some kind of service.

  11. [...] those of us without earned income, the standard retirement advice does not apply.  Not only do our workplaces (if we even have them) [...]

  12. [...] headaches for others.  Frugal Toad has a great infographic that paints a good picture of IRAs.Earned Income: The Bane of the Graduate Student’s Roth IRA - Yes it says graduate student, but it’s not a prerequisite.  What’s important is the [...]

  13. Heather says:

    Fascinating, thanks!
    Heather recently posted..Buy of the Day: Genius Hub

  14. [...] Evolving Personal Finance: Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  15. [...] @ Work Save Live added Earned Income: The Bane of the Graduate Student’s Roth IRA in his weekly [...]

  16. [...] to make a definitive statement…  It’s so frustrating!  I finished up my Roth IRA post today (going up Tuesday) and I’m glad to have found what I think is a definitive answer to [...]

  17. [...] order to contribute to a Roth IRA, you must have earned income. So if you get paid via fellowship, and get a 1099-MISC at the end of the year, the IRS does not [...]

  18. [...] Earned Income: The Bane of the Graduate Student’s Roth IRA was mentioned by Hedy @ Penny for My Thoughts. [...]

  19. [...] post in terms of being found by the wider internet is the one I did for the Roth IRA movement on the definition of earned income and whether or not graduate students can contribute to IRAs.  Apparently people really want to know this [...]

  20. Joe says:

    Why would you want fellowship income to be reported as earned income? The payroll tax (4.2%-6.2%+1.45%) that must be withheld from wages, along with the employer payroll tax (another 6.2%+1.45%), in my opinion, makes the unearned income classification better (as long as your university is properly classifying and reporting income consistent with laws and regulations)

    Invested wisely, the return on that extra (up to) 15.3% of income, in my opinion, compensates for the loss of the tax-advantaged account.

    And yes, yes, you lose the opportunity for Roth IRA contributions, but you can still make tax-deferred investments like US I-series savings bonds, or taxable low-turnover index mutual funds that defer tax on long term capital gains until sale.

    1. Emily says:

      Yes, that is a good point! I don’t know about you, but when I switched from being paid with a 1099-MISC to a W-2 I did not experience an decrease in before-taxes salary i.e. they employer doesn’t give the student what it would have paid in its half of payroll taxes, so you can only consider the student’s half a bonus. Perhaps you’re right than on balance it’s better to have the several percentage points increase in income invested in low-tax vehicles – I’m really not sure. My point isn’t so much that it’s better to be paid “earned income” but rather that we actually really DO work for our income so it’s a fictitious classification.

      1. Joe says:

        Actually thinking about it more, I think you probably have an argument. When you combine the payroll tax cut, the earned income tax credit, and if your university wouldn’t have given you their half of the payroll tax anyway, that is a good argument for the earned income classification if you intend on doing a maximum Roth contribution.

        If you don’t make IRA contributions (and there are plenty of reasons why a grad student wouldn’t) then the unearned income classification is likely better, though.

        Still, just because you perform compensated research, teaching, etc doesn’t mean that your income is “earned”. The IRS has complex rules for determining what counts as what. You (or your university) don’t get to just decide what is better in your particular situation. It does sound, though, like your university may not be correct in giving you a 1099-MISC.

        I’m just a simple grad student, not a tax accountant, so I am not a reliable source for information :)

        1. Emily says:

          I had to look up the income limits for the EITC – we make too much (and don’t have a child) so we’ve never taken it. I think if someone qualifies for the EITC there’s a pretty small chance she’ll have room to save for retirement unless she lives in a REALLY low cost-of-living city. I agree that from a money-in-pocket standpoint not having earned income is probably better for someone uninterested in taking advantage of a Roth. I’m not totally sure of the downstream implications of not paying payroll taxes during those years but I’m personally not anticipating those programs being around to benefit me later, anyway.

          I understand the IRS and universities have created rules to exclude fellowship recipients from having earned income. That is the way things stand. I just find their justification quite ridiculous and not reflective of reality for any PhD student I know. We are expected to work to stay in our programs and would be let go if we didn’t, but somehow that is not a condition of receiving our pay. And whether we’re paid by a fellowship or off our advisor’s grants we have the EXACT same job to perform – research, teaching, etc. If you have received a fellowship in grad school, what is your opinion? Did you work for your fellowship money? Or did you work for free, which your university enabled you to do by paying you?

  21. [...] weeks ago I got a great comment on my Roth IRAs for Graduate Students post from Joe.  He [...]

  22. [...] 4) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  23. Alex Kim says:

    Is earned income considered before or after tax? IF I made $5,000 earned income before tax, can I contribute all into Roth IRA account?

    1. Emily says:

      I believe it’s before tax, so yes. I assume that means you have some “unearned” income as well?

  24. imbriumar says:

    o_0

    This is somehow the first I have heard of this. I was funded through my phd on a patchwork of scraps from different training grants and a post-graduation t32 (and of course no retirement benefits). I thought having a Roth was my only real shot at trying to have some sort of retirement account. I thought I had researched it pretty well. I paid full taxes on my stipend (1099t) even though they weren’t withheld. I earned a little extra on the side (W2) but less than I contributed to the IRA overall. I never saw any paperwork about having a “fellowship” until the t32…my PI handled the backend of finances and basically answered “that’s my problem” if anyone asked about the specifics.

    It wasn’t easy on a grad student stipend living in the sf bay area but I was able to contribute about the equivalent to a year’s salary over my time there. I was particularly motivated in part because of a crappy medical diagnosis that has a nasty habit of knocking people out of the workforce early and the fact that even as a postdoc, I knew I wouldn’t have an external retirement account (now I am and I don’t and I work for a better employer than most).

    What do I do now? If money was contributed to the Roth that should not have been contributed…what happens? Who could I even contact to find out? Given our collective financial status, not many accountants seem to be specialized in ‘grad student/postdoc’ regulations.

    Sucks to be us…

    1. Emily says:

      1) Congratulations on getting through your PhD and postdoc on your various fellowships and grants, especially in the Bay area, and figuring out how to pay your taxes and such. That is a major accomplishment! Please don’t feel bad for not knowing all of this specific retirement information – very few people within universities do, in my observation.

      2) You’re totally correct that most tax and retirement specialists have no idea how to deal with grad student and postdoc pay. I would say they give out more false information than correct information. Your best chance may be to find a professional who is truly curious enough to research the situation and not rely on their general advice and then ask to see the IRS documentation that led them to their conclusions.

      3) If I were you and I decided to correct the over-contribution, I would hire a professional to figure out exactly how much I was allowed to contribute each year from my W-2s and other earned income, if any, and how to undo the contribution and pay the penalties. I would start by asking a local fee-only financial planner if she is able to do that and ask for a recommendation of another professional if she is not. If you decide to do this, the sooner you act the better as the penalties mount with time. Plenty of people other than grad students over-contribute to IRAs (for example, people who earn too much) so financial professionals should know how to undo part of the contribution even if they wouldn’t have been able to tell you on the front end not to do it. HOWEVER, I don’t know that I would correct the over-contribution now that it is done, given that it was an honest mistake due to vague/unknown IRS language and a number of years in the past.

      4) As for your savings going forward, I suppose you should keep it in non-tax-deferred accounts (there are low-tax mutual fund options, I believe) until you have a 401(k) option and then throw as much of the money as you can in there.

  25. [...] 5) Earned Income: The Bane of the Grad Student’s Roth IRA [...]

  26. research says:

    I really appreciate this information. I was shocked last year, when, for the first time, I had to pay a penalty for “overcontributing” to my Roth IRA. I am a graduate student on fellowship, and every penny is scrimped and saved for the future. The amount that I put into my IRA was a sacrifice- then I had to pay a penalty, and to fix the problem so I’m not charged again next year, I have to pay a penalty to the company that manages my IRA to move the contribution into another year (where presumably I’ll have the same problem). I’m taking on some odd jobs so that I can contribute… It all seems like a complicated way to punish us for trying to be responsible about our retirement.

    1. Emily says:

      Sounds like you did the right thing and found some workarounds. I’m sorry you didn’t know about these silly technicalities earlier so you could have avoided the charges.

  27. [...] or young professionals.  The most searched-for post I’ve written by far answers the question of whether graduate students receiving compensation with 1099s can contribute to Roth IRAs.  I want to have more posts like this that explore topics grad students may find difficult to find [...]

  28. [...] 4) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  29. [...] Evolving Personal Finance wrote Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  30. [...] 3) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  31. [...] It’s a good thing the fiscal year doesn’t match up with the academic year and IRAs were only 3K when we were first putting money away in them, because there were some academic years when all our income was stipend.  Though I think DH was paid the right way so maybe it would have been ok anyway given we were married.  Evolving PF explains what earned income is and how stipends are counted. [...]

  32. [...] For an explanation of another confusing point about graduate student income, read my post on earned income and Roth IRAs. [...]

  33. [...] at the end of 15 and 30 years of the investment account, assuming that it is growing tax-free (in a Roth IRA, for instance) at a rate of 8%.  In the first 15 years, the 15-year mortgage homeowner doesn’t [...]

  34. [...] which I am most proud is also the post that has generated the most search engine traffic – “Earned Income: The Bane of the Graduate Student’s Roth IRA”.  I laid out what kinds of graduate student pay qualify as “earned income” for the purposes [...]

  35. [...] 3) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  36. [...] 4) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  37. [...] on the blog – I listed not paying them as an advantage to being paid with a 1099-MISC and I had a good exchange with a commenter (Joe) about whether it’s better to be paid with a 1099-MISC or W-2 for investing purposes.  In [...]

  38. Alan says:

    Emily, great job on this, very helpful! However, I wanted to point out a paragraph from publication 54 which is otherwise directed towards U.S. citizens living and working abroad. I think it clarifies what we’ve all been wanting to know (from p.17 http://www.irs.gov/pub/irs-pdf/p54.pdf “Scholarships and fellowships. Any portion of a scholarship or fellowship grant that is paid to you for teaching, research or other services
    is considered earned income if you must include it in your gross income. If the payer of the grant is required to provide you with a Form W-2, Wage and Tax Statement, these amounts will be listed as wages.” I interpret this to mean that it is not just a W-2 that qualifies a grantee as having earned income but ALSO “any portion…of a…grant…paid to you for…research…is considered earned income if you must include it in your gross income.” And we know that the taxable portions of our grants must be included in gross income.

    If you can punch a hole in this…please do! I need to decide very soon if I can make my full Roth contribution for this year or not. After reading this publication I think I have a strong case to count the taxable portion of my NSF DDIG grant as earned income.

    1. Emily says:

      Unfortunately this passage does not change my opinion on the 1099-MISC vs. W-2 being the key indicator of whether or not income is ‘earned.’ Even though it doesn’t directly apply to domestic students, it jives with the passages I quoted in this post that say that if work is required, a W-2 should be issued instead of a 1099-MISC. A fellowship could result in W-2 pay if work is required, but if you are paid by a fellowship and receive a 1099-MISC indicates that ‘no work was required.’

      That said, I definitely think you have an argument – and it’s the same one I make, that we do in reality work no matter what kind of tax form we receive, and that it’s ridiculous to claim that our stipends are given without any expectations of work in return. Also take a look at Julia’s comment that says she received a W-2 for doing “no work.” I think that no one, not even the IRS, has definitive answers on these questions. But I’m not an advisor so I can’t make a recommendation!

  39. [...] 3) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  40. [...] you haven’t checked out my old post on grad students and earned income recently, you really should.  It’s my one post that continues to generate comments.  The [...]

  41. [...] 4) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  42. Pani says:

    What I have been reading elsewhere is that the calculation for what can be included in a Roth IRA contribution is: 1099-MISC Amount – (minus) Deduction for Employer-Equivalent Portion of Self-Employment Tax (from Schedule SE – Line 6; 1040 – Line 27).

    Here is an example:
    http://www.bankrate.com/brm/itax/tax_adviser/20070426_funding_Roth_IRA_a1.asp (Note: 1040 Line 26 in 2007 is now 1040 Line 27 for 2012)

    1. Emily says:

      In this post I am talking about income reported in 1099-MISC box 3. What you wrote about and what that article is about is self-employment income – 1099-MISC box 7. I haven’t researched self-employment income so I can’t offer informed opinions on that matter.

  43. Pani says:

    I need to correct that my previous post was too simplistic. 1099-MISC Amount counts as part of the calculation of earned income only if it is listed under Nonemployee Compensation, and only the part leftover in the net profit (Schedule C).

    1. Emily says:

      I’m not familiar with the Schedule C so I can’t comment on what makes for earned income for independent contractors.

  44. [...] discussions of other confusing points about graduate student income, read my posts on earned income and Roth IRAs and Social Security [...]

  45. [...] own posts on grad student taxes have been on persistent lies, Social Security, and IRAs.  I have a couple more planned for the next few months as [...]

  46. [...] very diverse – from people who had never seen a 1040 to people who were trying to argue that grad students should be paid with W-2s instead of 1099-MISCs.  I think our speaker did a great job covering the material, which was very difficult and [...]

  47. [...] My university issues a courtesy letter when it has paid a student’s stipend with a fellowship through payroll and the student has not set up income tax withholdings.  1099-MISC box 3 income and courtesy letter income are from the same type of source, a fellowship or scholarship, but in the case of the 1099-MISC the student has had taxes withheld.  Receiving 1099-MISC or courtesy letter income, at least at my university, means that the student is being paid through the non-compensatory payroll system.  If the student were paid through the compensatory payroll system, she would receive a W-2.  (Compensatory payroll is associated with being an employee, though I would certainly say that grad students receiving W-2s are still more “student” than “employee.”  Compensatory means you are being compensated for your work, whereas non-compensatory or fellowship income means you are being paid for… being you, apparently.  This hearkens back to the earned income debate.) [...]

  48. [...] 3) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  49. [...] have in tax-advantaged account invested in the stock market, for instance.  On the other hand, if you are paid by a fellowship and don’t have access to a tax-advantaged retirement account, perhaps paying down a mortgage is your best available investment [...]

  50. [...] 1) Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  51. [...] getting paid with a 1099 Misc instead of a W2 – no one believes this is “earned income,” which is what you need to contribute to a [...]

  52. [...] Earned Income: The Bane of the Graduate Student’s Roth IRA [...]

  53. Dylan says:

    Emily,

    Thanks so much for this post. More students need to hear this information.

    I am currently a graduate student in nutritional sciences at a public university in Florida. I have had my Roth IRA for about 2 years now. I am surprised time and time again that the university doesn’t do more to offer some sort of financial guidance/support to new students. This is a huge problem. I imagine that there are many students with investment products in a Roth without knowing the full requirements/regulations. Luckily, my graduate school uses W-2. Otherwise, I am not sure how I would have gotten out of this pickle!

    1. Emily says:

      Thank you so much for the encouragement!

      I’ve been on a personal finance committee at my university for about a year now, thanks to running this blog! We created a great tax workshop with a tax professional last spring and we got an hour for it during next year’s orientation! So the new crop of students for next year WILL know that they have to pay taxes and how to set up witholdings/pay estimated taxes and I’ll make sure the earned income information is slipped in there as well. Change is possible. :)

  54. […] with your department’s payroll, even if you are on the non-compensatory payroll (receiving a 1099-MISC at tax time instead of a W-2).  That way you will have an idea of how much your net pay will be […]

  55. […] I now cannot contribute to my Roth IRA from this portion of my income.  Fellowship/1099-MISC box 3 income is not considered “earned income.”  I hope this won’t turn out to matter much practically, though.  I’ve already received $5,500 […]

  56. […] students.  We (generally speaking) don’t pay Social Security taxes, but we also may not have the earned income necessary to contribute to IRAs.  I frequently write about personal finance issues that are specific to graduate students because […]

  57. […] one of my posts.  The post that I have gotten the most positive feedback on is my one clarifying what earned income is for a graduate student for the purposes of contributing to an IRA.  I love seeing search queries coming in that I know are leading readers to that […]

  58. […] which means I’m being paid by a fellowship instead of a grant, which means that I don’t have “earned income,” which means that I have no work requirement for receiving my pay.  Allegedly, I will be paid […]

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