Taxation of Egg Donors

Egg donors can expect to pay self-employment tax on the money they earn from their donations.

Egg donors are generally between the ages of 20 and 30, non-smokers with a normal height to weight ratio.

 

Egg donors typically receive between $5,000 and $10,000 for an egg donation.  And while you may feel that you are being compensated for pain and suffering, or that you are doing a charitable deed, the IRS treats that pay as self employment income.

 

How do they figure that?  Well, for one thing, there’s the 2015 Tax Court case of Perez v. Commissioner of Internal Revenue.  In that case, the court ruled that the money paid to Perez was indeed taxable income.

 

Now the Perez case really only argues whether the money is taxable or not.  It doesn’t actually argue the merits of whether it constitutes self-employment income,  but much of the language of the case implies that providing eggs and being compensated for it is a service business.

 

So, if you’re thinking about becoming an egg donor, you need to look at the tax consequences before you put your body through that painful process.  Let’s say you’re a first time donor and the fee you should receive is $5,000. Now suppose you’ve got a job already and you’re in the 15% tax bracket.  This extra $5,000 will be taxed as self employment income meaning that the 15.3% self employment tax on that income, plus the 15% regular tax on that income.  The self employment income is really taxed at 30.3% to you.  (And of course, it’s higher if you’re in a higher tax bracket.)

 

So if you’re getting paid $5,000 for the egg donation, then you’re coming out of the deal with just $3,485.  Here’s how the math works on that:

$5,000 times 30.15% tax rate equals $1,515 in taxes

$5,000 minus $1,515 in taxes  equals $3,485 to keep

The point here is that you’re not getting that $5,000 free and clear.  You’re actually earning less than $3,485 if you add state income taxes to the equation.

 

So what about the argument that you’re not providing a service, that you’re really selling body parts?  Okay, I have to admit here that I have a hard time with that argument.  I guess I’m a little old-fashioned.  (Excuse me, I can hear my daughter reading this and yelling, “A little old fashioned?  How about stone age!”)  But perhaps more importantly, it is still illegal to sell body parts in the United States.

 

But let’s take this argument to the extreme anyway.  What if you could sell body parts?  How would you value them? I think, I would use the example of livestock.  That’s as close as I can come to the body part argument.  If you buy an adult cow for $1,000 and later sell it for $2,000, you would pay a capital gains tax on the $1,000 profit from the sale of that cow.

 

But, if that cow gave birth to a calf while you owned her, and then you sold that calf for $500 – that $500 would be taxed as ordinary income.  It would be the sale of inventory that you didn’t pay for so the full $500 would be taxed as ordinary income.   And, since selling cattle would be your business – well then you would pay self employment tax on that calf that you sold.   I think that egg donation is more like selling the calf–you’re not buying the eggs to re-sell, you’re “manufacturing” then.  (You see how I find this a very uncomfortable argument?)

 

So whether you doing the egg donation as a “service business” or a “sale of property” business – you are still going to be subject to self employment tax on that income.  As you make your decision, take into account the taxes you’ll be required to pay and whether or not you’re being compensated fairly for your efforts.

 

 

 

 

 

 

S Corporation – Computing the Tax Savings

 

Run the numbers.

When deciding if you should elect Sub-chapter S corporation status for your company, you need to run the numbers first!

 

Electing to be taxed as a Subchapter S Corporation instead of as a Sole Proprietor could mean big tax savings for you as a small business owner. Notice I said could–because it’s not always the case. It’s really important to run the numbers – all the numbers – and do a comparison so you can make an informed decision.

This post is going to be a little technical. I apologize for that up front. I’m going to try to keep it in plain English though, because even if you can’t run the numbers yourself, you need to see what I’m talking about so you can discuss this with your accountant.

Here’s an example where I think choosing to be a Sub S Corporation is the right choice for a business owner: Jack Sparrow is a single, self employed pirate with net self-employment income of $100,000. (Yes, Johnny Depp was on TV last night.)  Jack has no other income to report on his tax return.

I ran the numbers for 2014 and it shows the total tax on the 1040 return to be $30,680. ($16,550 for the income tax and $14,130 for the self employment tax.)

That’s a lot of taxes!

But what if Jack were to set up a Sub Chapter S Corporation? He’d have to set himself up to receive payroll–(that’s part of the deal with an S Corporation, you have to pay yourself a salary) but the rest of his income would be taxed at his regular tax rate (they call that ordinary income) instead of at the self employment rate.

So for my example, I set Jack up with a payroll of $40,000, his S Corp income is $56,340 (not $60,000 because he’s paying some payroll taxes that are deducted.) So when I run the taxes for that, I’m showing that his total tax on his 1040 is $17,400.

Right here you’re probably going, “$13,280 in tax savings per year? Awesome! Sign me up now!”

But it’s not that simple. Because remember, part of being an S Corporation means that you must set up a salary for yourself and pay the payroll taxes. If you don’t include the cost of those payroll taxes in your calculations, you’re not giving yourself a true comparison of the total tax cost.

For Jack’s example, we set up a payroll for $40,000. From his $40,000, Jack will have $3,060 withheld as his employee share of FICA-that’s the Social Security and Medicare tax that gets withheld from everyone’s wages.  Also, remember when I said his S Corp income was $56,340 instead of $60,000? That’s because as an employer, Jack also had to pay an additional $3,060 for the employer’s share of FICA, and I added another $600 for state and federal unemployment taxes. The unemployment tax will vary by state but $600 is a reasonable estimate.

When you add those payroll tax costs to the 1040 tax cost, Jack’s total S Corp taxes are now $24,1120. That’s still a big tax savings of $6,650! In this case, of course I would recommend that Jack go for the S Corp.

Just for fun, what if Jack were offered a pirate job as a wage earning position? All W2 income with no self-employment at $100,000 per year? Just running the numbers straight like that,  his 1040 taxes would be $18,341 and his FICA withholding would be $7,650 so his total tax cost would be $25,991 which turns out to be $1871 more than his S Corp taxes.

Now in real life, there would be other considerations – like health insurance and other fringe benefits that might make Jack want to jump at that wage position.  But I left all of that out for this comparison.

The chart at the bottom of the post shows the numbers for Jack’s case side by side so you can see how I got to my numbers, in case you want to replicate them for yourself.

So, how do you determine if YOU should have an S Corporation instead of a sole proprietorship? You look at these numbers and it’s pretty persuasive. If you could save $6,000 or more a year, who wouldn’t do that? But taxes have a lot of moving parts these days. Maybe you have investment income, maybe you have wages from another job. Maybe you have deductions that are allowed on a Schedule C that aren’t allowed for an S Corp. Healthcare costs can also make a difference and so can your retirement savings goals.

If you don’t run the numbers fully through a tax program, including the payroll tax costs, you could actually lose money going with an S Corp. I ran a scenario the other day – this is a real person’s actual numbers: her tax savings by converting to an S Corp–before adding in any payroll taxes, was only $1,338. She’d spend that much in accounting fees for the payroll and additional tax return. Adding in the FICA and employer payroll taxes we send her to the loss column. I never would have known that had I not sat down and ran the numbers based on her whole situation.

While that taxpayer’s situation was unique, your situation is also unique to you. Before electing to be an S Corporation, make sure you have all the facts and run all the numbers.  You’ll be glad you did.

 

Here’s that chart I promised you:

Comparison of wage, vs. self-employment, vs. Sub S Corporation taxes

Comparison of wage, vs. self-employment, vs. Sub S Corporation taxes

Tax Planning Isn’t Rocket Science, But it Can Save You Money!

Tax planning can save you money.

You don’t have to be a rocket scientist to do a little planning ahead to save big dollars on your tax return.

Today I want to talk about tax planning, and  why it’s so important.

 

I recently got a call from a woman who wanted to take $30,000 out of her IRA to buy something special.  She went to her financial planner to take the money out and he told her that she needed to take another $7500 out just to cover her taxes, but to talk to a tax person first.  So she called me.

 

Well, I ran the numbers for her and if she took $37,500 out of her IRA , it was going to cost her over $9,000 in state and federal taxes combined.  Even though she would be withholding $7500 for her federal taxes, she’d still have to come up with another $2000 to be whole.  Then we started talking.

 

You see, she didn’t need to make the purchase right away, she was just thinking about it.  So I decided to see what would happen if we split the $30,000  between 2013 and 2014, $15,000 each year.  What a difference!  Instead of paying over $9000, she’ pay $688 per year total for her state and federal income  taxes combined.  That wasn’t a typo–six hundred and eighty-eight dollars a year.  $1376 total tax for a savings of over $8000!

 

So by waiting for another 60 days to take half the money she wanted out of her IRA she’d save $8000.  How cool is that?

 

In fairness, the woman’s particular situation just put her into a sweet zone for this to work out so well.  For many people, splitting up the IRA withdrawal  would not save them any taxes at all.  But my point is–how do you know?   By taking the time to ask–she saved $8000.

 

What’s going on in your life that could benefit from a little tax planning?  Selling some stocks or mutual funds?  Donating to charity?  Do you own a small
business?   Are you getting married?  Getting divorced?  Having a baby?  Getting a new job?  Buying a home?  Any of these events, and many more, could use
a little tax planning.

 

My business card says, “If you don’t have a tax strategy, you’re probably paying too much.”    It’s true.  So often in my job, I’m trying to help people who’ve already made decisions and come to me when its’ too late to make changes.  Why would you want to give the IRS more money then you need to?  It’s not rocket science, it’s just common sense.   The best way to keep more of your money is to make a plan for keeping it.  Call me.  I can help.

Why Doesn’t My QuickBooks Income Match the Income on my Tax Return?

(Explaining the Schedule M1 for Dummies)

Photo by Jenny Kaczorowski at Flickr.com

 

So you’re a small business owner and you just got your business return back. You take a look at the tax return and it says your net income is $20,000 but you gave your QuickBooks profit and loss statement to your account and it said that your income was $15,000. What happened? Maybe instead it was the other way and your tax income was lower. What’s up with that?

 

Well first thing, if you have an accountant doing your taxes, she should be able to explain exactly what’s going on. (If she can’t, it’s time for a new accountant.) But the simple answer is right on your tax return. It’s called the Schedule M1. If you’ve got a corporation, it will be on page 5 of the tax return. If you’ve got a partnership, it’s on page 4, right underneath the balance sheet.

 

Schedule M1 is the part of the tax return that explains what’s different between the books that you handed your accountant and the tax return that you’re giving to the IRS. If you had less than $250,000 in revenue, you don’t need to submit an M1 to the IRS (tax programs will leave them blank), but it’s still a good idea to complete those schedules to make sure your books are straight.

 

So what are the most common discrepancies between tax and book income? That’s easy; you’ll find it in the meals and entertainment category and depreciation. If you don’t have expenses in either of these categories, most likely your tax income and book income are going to match up just fine. But if you do have meals and entertainment or depreciation, they almost always affect your tax income.

 

Let me explain the meals and entertainment first. That’s the category where the IRS only allows you to claim a 50% deduction on there. So let’s say you spent $3,000 in meals and entertainment. On your tax return, you’d only get to expense $1,500. That means there’s another $1500 expense that’s recorded on your books that’s not on your tax return.  So, in this example your tax net income is higher than your book income.

 

Depreciation usually goes the other way.  Often small businesses ignore depreciation.  Or they run depreciation through their software program, but it’s not the same depreciation schedule that’s used for taxes.  For example, using the straight line method for book purposes but using the Modified Accelerated Cost Recovery System (MACRS) for tax purposes.  Usually that makes for a tax adjustment the other way.

 

Let’s look at an example so you can see what the Schedule M-1 looks like and how it affects your net income.  In the example below, the business owner showed $20,000 of net income on his QuickBooks profit and loss statement.  He had $2,600 of travel and entertainment expenses, so half of that get’s added to his taxable income.  He also had $4,500 of depreciation that showed up on his tax return, but he didn’t include in his QuickBooks, so that reduces his taxable income.

 

$20,000 (net income from the profit and loss statement) + $1300 (half of the meal and entertainment expense) – $4500 (the depreciation expense) = $16,800 (the net income shown on the tax return)

 

 

There are lots of other items that can affect the Schedule M1.  These two are so common that many tax programs automatically plug them in for you.  Another common item that might show up on the M-1 is when you’ve got an expense on your profit and loss statement that your accountant says, “No, you can’t count that on your tax return.”    (We don’t do that to be mean, we just don’t look that good in prison orange.)

 

Why you want the Schedule M-1.  Let’s say you file your business tax return and you get audited by the IRS.  The first thing they do is ask for your profit and loss statement and your bank records.    The examiner takes one look at your P&L and sees you have net income of $20,000—but you’re tax return says you made $16,800.  He’s licking his chops because he gets to assess you additional taxes and he hasn’t even opened your bank statement yet.  Aha!  You’ve got your M1 showing the depreciation.  Your butt is covered.

 

Now in real life, the IRS examiner would notice the depreciation eventually anyway.  But sometimes there will be items in the M-1 that aren’t so obvious.  That’s why you want this reconciliation, because by the time the IRS gets around to auditing your books, you’ll forget the little adjustments—unless they’re tracked.  M-1 keeps you neat and tidy.