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

If You Could Change the Tax Code, What Would You Do?

The Jan Tax Plan

Line to get in to the Convention

Photo by graham.davis at Flickr.Com

After two weeks of political conventions I thought I’d know a whole lot more about the tax plans for the Republicans and Democrats. Oh, I’ve heard some high minded ideal stuff—but not much in the way of nuts and bolts. If you’d like to do a comparison, you can check out the Tax Foundation’s website to see how they compare and how they compare to the Simpson Bowles plan too: http://taxfoundation.org/article/romney-obama-simpson-bowles-how-do-tax-reform-plans-stack


But since Romney and Obama didn’t give me what I wanted to hear, I decided to make up my own tax plan. To be honest, it’s more of a reflection of problems that I see with tax returns that I actually work on but these are the top changes that I would make if I were in charge.


1. Earned Income Tax Credit: First I’d reduce EIC payouts by 10% per year until it’s reduced by 30%. In order to claim EIC for a child, you’d be required to produce the child’s report card with passing grade. Why the cuts and why the extra requirements? First, the EIC credit is so high right now that it encourages fraud. Currently, the IRS estimates that between $12 to $14 billion dollars of EIC fraud occur every year. If the payout wasn’t so high, the temptation for fraud wouldn’t be so great.


The extra requirements would help ensure that the kids in our communities get a better education. Everybody gives lip service to more education, and parental involvement is key to kids succeeding in school. Well, if your kid is required to pass school in order to get the Earned Income Tax Credit, I think we’d have a whole lot of parental involvement. No report card, no money.


If the child is too young to attend school, a current immunization record would be required. It’s proof that the child is getting proper medical treatment.


One more thing on EIC—if a person is caught fraudulently claiming a child on his/her tax return, the penalty, besides paying back the tax, should be never being able to claim EIC again. Ever! I work with a lot of the EIC fraud victims, I think they’d really like that rule.


2. Self-employment income: If you receive 1099 MISCs and the total amount is less than $4,000—you should have the option to elect to count that as “hobby” income instead of automatically being taxed as self employment. Currently, if you receive a 1099 MISC, it’s counted as self employment and taxed an extra 13.3% on top of your regular taxes. For someone like me, that’s fine. I own my business, I write of my expenses—it’s the way it works. For many people, they have no clue they’re considered self employed. The small amount of income is a hobby or not a real business. $4,000 to me seems to be the break point between hobbyists and business owners.


I say, that if you elect to claim the income as “not self employment” then you can’t write off expenses. If you elect to claim that you’re in a business, you can’t go back later and call it a hobby in later years. That keeps people from jumping back and forth.


3. The Alternative Minimum Tax: This one is my pet peeve. The AMT adjustment was set in 1969 and hasn’t been adjusted. Right now, Congress basically votes for a “patch” every year. Why they wait until December to do it is beyond me. I say that we should adjust the AMT threshold for inflation and automatically adjust it every year to correspond to the rate of inflation. Normal people can’t plan their taxes without knowing about AMT. The fact that this has been going on for so long is ridiculous.


I could probably go on and on but these are my top three. What would you change if you could fix the tax code?

Small Business: Proving You Have Income Without a 1099-MISC

Good records will prove your income to the IRS.

For some small businesses a simple wire bound receipt book is all you need to substantiate your income.



Now some people may be wondering, “Why would I want to prove I have more income than I have to?”   But for many small business owners, that’s exactly the problem—you have income, you want to report it to the IRS, and you’re having a hard time proving it.  This post is for you.


The number two reason for reporting your non-1099 income  (number one of course being basic honesty) is qualifying for the Earned Income Tax Credit.  2011 sort of hit small business owners who normally qualify for EIC with a one-two punch.  We had the new 1099 reporting requirements that upped the ante for so many businesses, and we had the new EIC tax preparer due diligence rules with one of the questions being “Do you have forms 1099-MISC to support the income?” With the next  question being, “If not, is it reasonable that the business type would not receive Form 1099-MISC?”  Here’s a clue:  if you answered NO to the first one, you have to answer YES to the second.


So what types of businesses wouldn’t normally receive a 1099?  Bunches of them!  Face it, if you’re reading this—I’m guessing that your business doesn’t receive 1099s.  Generally, it’s reasonable to expect that anybody who works for other people, as opposed to other businesses, would not receive a 1099.  House cleaners, dog walkers, handymen, lawn mowing services, daycare  providers, interior decorators, and even income tax preparers are all types of business that could easily never see a 1099.   (Yeah, me too!  Although I’m now getting 1099k forms because I take credit cards, I don’t get 1099-MISC for preparing personal tax returns.  Maybe I’ll see some 1099-MISC forms from some of my business clients this year, but I never used to get them in the past.)


So, how does a small time personal service provider prove his or her income to the IRS?  There are a couple of things you can do.  I’m going to start with my favorite:  the business bank account.  This is what I do and several of my clients do it too.   (Okay, because I’m their accountant and this is what I tell them to do.)   Get an Employer Identification Number (EIN) for your business and set up a separate bank account for your business in your business name.  Only business income goes in, only business expenses go out.  You may have to put some of your own money in for a start up, and once you’re making money you’ll take out a draw, but you’ll label those as such.  Other than those two items, your business checking account is pretty much your profit and loss statement as well.  Now for a bigger company that would be over simplifying things, but for us little folks–I’m spot on.  See this post for more information about getting an EIN number:  Free EIN


Why does this make good proof?  Because you’ve got a monthly record of your income and expenses.  I also have deposit slips to back it up:  Mary Jones paid me $200, Fred Smith paid $250.   It’s a good solid audit trail.  Here’s another post about bookkeeping and your business bank account:  Banking and Bookkeeping


But what if you don’t have a separate account?   Maybe your business is just too small to bother with the expense of an extra account.  What if you’ve just got something really simple like watching the little neighbor kid for a couple of hours after school every day.  There’s no contract, no business cards, no advertising.   You get $100 a week from your neighbor friend.  She pays you in cash—it never sees the inside of a bank because that’s your grocery money.   It’s not much but it supplements your child support.  How do you prove that kind of income?


The easiest way to prove your income if you provided child care is to have the person you provided it for claim your services on their tax return.  You make them a daycare receipt, just like the ones regular day cares do showing the name of the child, how much they paid you and your EIN number.  (You can use your social security number but I never recommend that.  You can get an EIN number for free.  Protect yourself.)  This is doubly good because the IRS will get confirmation of your income from an outside source.  You prove income, your customer gets a tax deduction, it’s a win/win situation.


But what if your business isn’t day care?  What if you did something like mow lawns around the neighborhood and shoveled snow in the winter?  Nobody’s going to be claiming you on their tax return, what can you do?  In your case, I like receipt books.  You can find different kinds at Office Max or any office supply store.  I like the ones with a carbon copy—one for you, one for your customer.


Now if you have just one customer and you’re always going to the same place—you can just use the little one that just has a couple of lines and the amount on it.  You might write, “Mowing, Mr. Jones, $30, 5/15/2012” on it.  You know what you did, who you did it for, how much you got paid, and when.  If you have multiple customers you’ll want the larger receipt books that include the address and phone number of the customer.  If you do different types of jobs for different people, you might need the bigger ones so you can write down the type of work that you did for them as well.


You don’t have to have a 1099-MISC to prove your income to the IRS.  You just need to have a system in place to document your income and you’ll be fine.

Estimated Taxes for Small Businesses

Income Tax

Photo by Shayne Kaye on Flickr.com

I’ve gotten this question twice in the past week so I thought I’d post it on my blog:

I pay my estimated taxes out of my personal account, but really I’m paying estimated taxes for my small business, shouldn’t I take the money out of my business account?

That’s a really good question, and the answer is “It depends.” If you own a C corporation, then the answer is yes. But most of the small businesses I deal with are Sole Proprietors and Sub S Corporations; if you have one of those, the answer is NO!

Here’s why Sole Proprietors and Sub S Corporation Owners should not pay their estimated taxes out of their business accounts: All of the profits from these kinds of companies are taxable to the individual that owns them. The companies themselves pay no tax, the individual owner does. Because the owner, not the company, owes the tax, the owner must pay from his personal account.

Let’s do an example: Daisy Duke owns Daisy’s Delightful Doggie Daycare (D4). It’s basically a pet-sitting business she runs out of her home. Daisy’s pretty savvy about accounting, so she maintains a separate bank account for her business and she claims every legal deduction she’s entitled to. She runs all of her business expenses through her business account.

For the quarter, Daisy has $10,000 of income and $6,000 of business expenses. She wants to make an estimated payment on the remaining $4,000 of income. Daisy determined that she spends 40% of her net income on federal taxes so she’s going to send $1600 to the IRS. This check is not written on the D4 checking account, but instead on Daisy’s personal account.

Note that Daisy runs all of the business expenses through the business account, but because the taxes are not considered to be a business expense, they can’t go in there. If Daisy were to take her kids to Chuck E. Cheese’s for pizza, she would not pay for that out of her D4 account either. Now it’s sounds crazy equating estimated tax payments with Chuck E. Cheese’s Pizza but to the IRS’s eyes, they’re the same thing—a personal expense.

So here’s the next question that people always ask: What if Daisy doesn’t have enough money in her personal checking account to pay the taxes? That’s another good question. Remember, though, that the reason Daisy has to pay estimated taxes is because she’s making a profit. She’s got that $4,000 of profit sitting in her business bank account. She can make a payment to herself because she owns the company. She’s paying herself a draw (or maybe with an S Corp a salary), but when you own the business and you have a separate business account, you are allowed to pay yourself from the account.

Next question: But isn’t it a waste of time? Aren’t you writing two checks-one to Daisy and then one to the IRS, when writing one check directly to the IRS would solve the problem? No, it’s not a waste of time because it’s worth the extra five minutes to keep your books straight.

If you keep your business books strictly for business, with no personal expenses running through there at all, the IRS is going to think you’re pretty boring and not worth wasting much time on trying to audit you. This is one of those times where boring is good! Remember, paying your estimated taxes out of your business account is seen to be the same as taking your kids to Chuck E. Cheese’s Pizza. It’s a cheesy expense! (Sorry, that pun flew out of the keyboard, I couldn’t stop it.)

Many small business owners get into tax trouble because they wind up using their business accounts for personal spending. While your estimated tax payment seems like it would be a business expense, it’s not and you have to keep it separate.

See also: http://robergtaxsolutions.com/2011/04/how-do-i-keep-from-owing-so-much-tax-next-year-estimated-tax-payments/

Small Business Taxes for Beginners: How Much to Set Aside


self employment tax

When you start a new business, one of the hardest things to figure out is how much money you need to set aside to pay your taxes.

One question I hear all the time is: How much should I put away to pay my business taxes? If you’ve been in business for a few years, you probably have a good feel for how much you take in versus how much your expenses are and what your overall tax bracket is. After a while, you’ll be able to make estimated tax payments with fairly good accuracy. But if you’re just starting out and you don’t have a lot of experience, it’s really hard to guess. This post is for you.

Starting with the very first payment you receive, put away 10% of your revenue. Ideally, you will set up a special savings account at a bank to escrow your taxes, but you can use a piggy bank at home for all I care. Set aside 10% of your revenue.

But I thought my self-employment taxes were more than that? They are. Generally, self employment taxes are 15% of your income, and then you pay your regular tax rate on top of that. If you’re in the 25% tax bracket, the taxes on your business are 40%. This puts people into a panic—most people don’t pay 40% of their revenues, you have to back out your expenses first.

So shouldn’t I put away 40% of my profit? Yes, after you’ve got your business settled in and running smoothly. In the beginning, most start ups lose money, so your business taxes might be zero. You could even reduce your other taxes by reporting a business loss. Setting aside the 10% is your safety net. 10% is easy. 10% is a number you can live with. Most importantly, 10% might save your life.

You were right, I had a loss my first year. Can I spend the tax money that I had set aside? No. You’re going to add to it the next year so that you’ll have enough money to pay taxes then.
What if I have a loss for my second year of business? Keep setting aside 10%. There are basically three things that could happen:

Eventually your business will start making a profit and you’ll be glad that you set aside some money to pay your taxes.

Your business will never make money, so the IRS will decide to call your business a hobby and you’ll have to pay back the taxes you avoided by claiming business losses. We don’t want that to happen! But again, you’ll be glad you have that money set aside.

Your business doesn’t make any money and you’re smart enough to get out before the IRS declares you to have a hobby. Now you’ve got a nice little savings account started.

The 10% rule is a win/win situation for you no matter what.

I make really good income as a contract laborer and I don’t have any expenses. What if I expect to definitely make a profit my first year? A good example of this situation would be an independent IT contractor; a lot of these folks are profitable from day one. If you’ve got a similar situation, I’d hold back 25% at a minimum, 30% is better. If you’re married and you’re adding your income onto a spouse’s earnings, I’d put away 40% right from the start. If you anticipate over $100,000 of income your first year, you should sit down with a professional and do some strategy planning. Your self-employment taxes will actually go down after $106,800 but you could be in a higher overall tax bracket.

Face it, if you’re making over $100,000 a year, you can afford to pay the consulting fee to an accountant. By the way, you’ll write that off as a business deduction.

Okay, so I set aside 10% of my revenue for my business taxes the first year but it wasn’t enough. Now what do I do? First, be glad that at least you had the 10% set aside. Now you’ve got some figures to work with for next year. Based upon your tax return, you can now compute a percentage for you to set aside. Maybe it’s 20%, maybe 30%. Once again, you’ll set aside a percentage of your revenues. You’ll make estimated tax payments every quarter based on what you owed last year. Let’s say you had a balance due of $4,000 last year, then you’ll make quarterly estimated tax payments of $1,000 each this year. You’re still putting money in the bank for your taxes and you’ll pay the estimated taxes from your set-aside fund.

I see a lot of people with small businesses get into tax trouble. They scrape to get ahead and then when success finally comes, the tax bill is a big slap in the face. Success is sweet, but there’s a price. If you start from day one setting aside a portion of your revenue for taxes, you’ll be prepared.


Missouri Tax Credit for Self-Employed Health Insurance

MO self-employed health insurance tax credit


One of the really fun parts of my job is finding cool tax deductions or tax credits that most people don’t know about that can really benefit people.  Here’s a cool one:  The Missouri Self-Employed Health Insurance Tax Credit.


The thing about Missouri Tax Credits is that most of them won’t just pop up on your computer software.  You have to actually know about them and specifically request the forms to come up.  Major things, like the Missouri Property Tax Credit will usually have a pop-up reminding you to apply for it if you meet the criteria, but most other tax credits just hide in the corner.  The Self-Employed Health Insurance Tax Credit is one of the sneaky, hide in the corner credits.


How sneaky is it?  To tell you the truth, I called the Missouri Department of Revenue to ask a few questions and the person on the other end of the phone had never even heard of it.  She had to go hunt down someone who knew about the Self-Employed Health Insurance tax credit before she could answer my question.  I’ve never had that happen before.  The Missouri Department of Revenue front line folks are pretty knowledgeable and quick with answers.  While I tend to stump the IRS on a regular basis (I think if they had caller ID they’d never answer my phone calls,) I’ve never stumped a Missouri DOR employee before.


Here’s how it works:  Let’s say you own your own company and you also pay for your own health insurance.  Normally, on your federal tax return, you can claim a deduction for your health insurance up to the amount of your business profit.  But what if your business didn’t have a profit?  Or if your business profit was less than what you paid for your health insurance?  That’s where the Missouri Self-Employed Health Insurance Tax Credit kicks in.  Whatever tax savings you lost on your federal income tax return because you couldn’t claim your self-employed health insurance will become a tax credit to you in Missouri.


I know that sounds pretty confusing so here’s an example:  Let’s say your federal taxable income on your 1040 was $100,000 (I like to use round numbers.)  But you couldn’t claim your self-employed health insurance because your business actually had a loss (we’ll assume the $100,000 is from your spouse’s wages and other income.)  Your health insurance cost you $6,000 for the year.  If you could have claimed that as a deduction, it would have saved you $1,500 on your federal tax return.  With the Missouri Self-Employed Health Insurance Tax Credit, you get to take that $1,500 as a credit against your Missouri state income tax liability.  How cool is that?


Now that was a pretty drastic example, but even so, claiming a dollar for dollar tax credit against what you missed out on from your federal income tax return is a great deal.  Here’s a link to take a look at the form:

Missouri Self-Employed Health Insurance Tax Credit


So you want to know the best part?  Many of the Missouri tax credits have limitations that, if missed, you don’t get a second chance to claim them.  But with the Self-Employed Health Insurance Tax Credit, if you happened to miss out on claiming this credit last year, you can go back and amend your prior Missouri tax return and still get the refund.



How to Get an EIN Number for your Business for Free

Free EIN number

You can get an Employer Identification Number for your small business for free at the IRS website.

If your business needs an EIN (that’s an employer identification number), it takes about 5 minutes on the IRS website and you can get one for free.  I mention this because I found a company online that will do it for you for $75.  For an extra $75, they’ll put a rush on it.   So you can pay $150 for the rush job, or you can do it yourself for free in less time than it takes to fill out their online payment agreement.

The first step is to go to the IRS website. This link will take you right to the EIN page.

IRS EIN link

This page has links to a lot of information so it’s pretty useful.  It also has the link to go to the EIN application.  The online application has limited working hours, you’re not going to be able to file the application at 3 in the morning.  They’re basically open from 6 am until a little after midnight Monday through Friday with limited weekend service.

Before you actually apply for an EIN, think–do you really need one?  If you’re a corporation or a partnership, the answer is yes.  If you are an LLC, that means you are a limited liability company-that does not make you a corporation, so just because you are an LLC doesn’t mean you need to have an EIN.   Other reasons for needing an EIN include if you have employees, need to pay excise taxes, are a non-profit organization,  trust or estate.

You might not need an EIN per IRS standards, but it may be beneficial to your business anyway.  For example:  if you work as an independent contractor and do not want to give your social security number out or you are setting up a bank account in your business name.  Some vendors won’t give you business discount rates unless you have an EIN number, and I had one client who needed one because a vendor wouldn’t work with her at all because she didn’t have an EIN and she really needed the account.

Generally,iIf you are working as a contract laborer and filing your return as a sole proprietor, it’s most likely that you do not need to have an EIN number.

Applying for the actual EIN:  I recommend using the online application.  The application is presented in an interview style format.  It asks questions, you answer them and when you get to the end. voila’ you have an EIN number.  It sort of has a dummy proof mode too that let’s you tab back if you’ve answered a question incorrectly.  I recommend having access to a printer when you do it so that you can print out your new EIN when you’re done.  You don’t want to lose that number once you’ve got it.

Before you do the online application, you might want to check out the written application form so that you have all of your information handy before you apply:  http://www.irs.gov/pub/irs-pdf/fss4.pdf

To go straight to the online application, click this link:


On little glicth, for some reason, if you  need an EIN because you receive home health care services, you can’t apply for your EIN online, you have to use another application method.  I suggest calling on the toll free number:  1 (800) 829-4933.  That’s the toll free number for the tax and business specialty hot line.    You will have to wait on hold for awhile, but it’s still faster than using the mail.

Small Business Basics


Deduct all of your legitimate business expenses


I’ve done a lot of posts about unusual small business deductions, but I haven’t done anything about the basics.  If you’re new to the small business world, that’s what you really need to know.  These are some of the basic, core facts that you need to know to prepare your small business taxes.


First, if you’re just starting out, and you haven’t filed any papers like articles of incorporation, and you don’t have any partners, then you’re considered to be a sole proprietor.  Your business tax return goes on a form called a Schedule C, and that’s part of your regular 1040 form.  Don’t file your personal taxes and then try to file your business return later, they’re one and the same thing.


What if I’m an LLC?  An LLC is a limited liability company, it’s not a corporation.  Most LLC’s will file as sole proprietors unless they have filed documents to be taxed as an S or C corporation.  (Then they file corporated tax form 1120S or 1120.)  LLCs that have partners will file partnership returns, form 1065.  This post is about sole proprietors who file Schedule C with their 1040 return.


A popular question I hear is, “How much money do I have to make to file a return?”  According to the IRS, if you make over $400 of self employment income, you are required to file a federal tax return.  This is very different from the minimum filing requirements of regular returns.  Once you’ve made over $400, that income is subject to self employment tax and the IRS is very keen on collecting your self employment tax.


Another common question is, “How will the IRS know that I’ve made over $400?”   The easiest way for the IRS to find out your income, assuming that you haven’t reported it yourself, is from forms 1099MISC.  Many companies hire people as contract labor and don’t withhold payroll taxes.  If you make over $600 from them, they are required by law to give you a form 1099MISC, showing how much they paid you.  A copy of that form also goes to the IRS.  That’s the most common way small businesses can get in trouble for underreporting their income.


Another way the IRS can find out that you’re not reporting your income is through your bank records.  Let’s say for example that all of your business transactions are for cash and you never receive a 1099MISC.  Although you wouldn’t get caught as quickly, let’s say you had an annual income of $20,000 from your all cash business.  Your spending would be out of line with your income and could trigger an audit.  A quick look at your bank statements would prove you weren’t reporting your income.  If you’re serious about starting a real business, do it right and have a plan for handling your taxes.  It will save you a lot of trouble in the future.


Small business income, unlike wage income, has one big disadvantage–it get’s taxed twice.  First, it’s taxed at your normal tax rate and then again at the self employment tax rate (15.3%.)  Let’s say you’re already in the 25% tax bracket for another job you have, your self employment income would then be taxed at 40% (the 25% plus the 15%.)


Small business income also has one big advantage–you can reduce your self employment income by any expenses you had acquiring that income.  You may even have more business expenses than you have income, in that case, you can use your business losses to reduce your regular income, that lowers your overall income tax bill.  Now you don’t want your business to be losing money every year (that’s not really good business practice.)  But when you’re starting up, being able to deduct your losses is very helpful.


So what kinds of expenses can you deduct?  The key phrase that the IRS uses is anything that is “regular and necessary” for the business.  A good guideline is right on the Schedule C form.  Here’s a link to it right here:  Schedule C.  Advertising, legal and professional fees, auto expenses, insurance, rent, repairs and maintenance, supplies, and office expenses.   Meals and entertainment are deducted at 50% of what you spend (since the idea is that you’d have to eat anyway.)


If this is your first time filing taxes for your small business.  I recommend getting a professional to help you.  Even if you have a knack for the paperwork, it really helps to have someone else go over the possibilities of what you can deduct and make sure that the big things like depreciation (if you have that) are handled correctly.  If you get started on the right track, it’s easier to stay that way.


Business Expenses for Unusual Occupations

Charlee Chartrand as Superman from the Post Dispatch article, see link for full story.

 What do you do for a living?  Are you in advertising, construction, real estate?  When you tell people what your job is do they seem to have a grasp of what that means?  Some people’s jobs aren’t so easily defined, like Superman for example. 

Actually, his name is Charlee Chartrand and he dresses as Superman for his job.  This is not your every day occupation.  Now I don’t know Mr. Chartrand and I don’t do his taxes, if I did, my confidentiality rules wouldn’t allow me to talk about him.  I read about him in Sunday’s Post Dispatch.  I did contact him and ask for his permission to use him as an example though.

The main part of Mr. Chartrand’s job is that he dresses as Superman, hangs around at Cardinals games and collects tips for posing in pictures with  fans and tourists.  He’s also been performing at birthday parties.   If you think there’s no money in this, think again, he can earn as much as $400 in tips in a day.    And that’s why he’s going to need to figure out his deductions before he files his tax return.

So what can Superman deduct?  Let’s hit the obvious thing first:  the costume–all of it.  Cleaning, repairing, replacing, clearly this is one clothing expense that will count as a business expense.  I would also include his undergarmets.  You can’t dress as Superman and wear any old boxer shorts.

The hair:  most of the time hair cuts and styling products, etc are not considered legitimate expenses for business, even if you are a professional actor or television personality.  In Superman’s case here, I would claim his hair expenses.  He has to dye his hair black to be Superman, and he uses four different products to get just the right effect–including the “S” shaped curl on his forehead.  I think that goes far beyond what would be normal for Mr. Chartrand during his off duty hours.  

I can’t tell from the photo if Superman is wearing make-up or not.   He doesn’t look like it, but if he was, I’d allow it.  (He might need to darken his eyebrows to match his hair.)    A note about make-up:  generally, make up is frowned upon by the IRS as a business expense.  A clown wearing clown make-up would qualify for a deduction, but most women in any business would not.  I once helped a dancer with her return and as we went through her expenses she claimed “a gallon of eyelash glue.”  Now, I thought that was an excessive amount even for a professional dancer.  “Not for eyelashes,” she said, “It’s to keep my costume on!”  Evidently, during a dress rehearsal she had had a “wardrobe malfunction”.  In order to keep herself looking decent, she glued her costume on to make sure she stayed covered.  That clearly fit the category of “necessary” and I put it in.  (Even the meanest IRS agent couldn’t argue that one.)

Let’s get back to Superman,  He can probably claim either a home office deduction or rent for his work space.  And, since he travels from his home office to his gigs, he can deduct his mileage as well.  These are expenses that are pretty normal for many small businesses.  It’s important to remember that even unusual businesses have normal types of expenses.  Another normal type of expense for Superman might be advertising, if he has flyers or cards that he distributes to get new business.

Here’s another expense that I would use for Superman that might seem out of the ordinary:  comic books—Mr Chartrand uses comic books to compare against his costume and maintain the authenticity of his look.  I’d count it as a valid business expense. 

Also, Mr. Chartrand has a goal of moving to Los Angeles.  Making a permanent move to Los Angeles would count as a moving expense, as opposed to a business expense.  But, if Mr. Chartrand makes a trip to Los Angeles, to test the market so to speak, he could probably write off most of that stay as a business deduction.  This would give him a chance to test out the market and give himself an out to come home if he found Los Angeles wasn’t the place for him. 

When claiming business deductions, the key phrase the IRS uses is “ordinary and necessary”.  

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.

When you’ve got a one-of-a- kind type of career, it’s not always easy to figure out what ordinary means.  Hopefully, Superman’s example can give you some ideas about what’s ordinary and necessary for your business.

To read more about Charlee Chartrand, aka Superman, this link will take you to the St. Louis Post-Dispatch article about him:

Superman Story

Small Business Bill Passes!

The small business bill that’s been kicking around in Congress (for what seems like ages) has finally passed. I usually don’t get too excited about small business bills because what Congress considers to be a small business is much bigger than the business I’m in or the ones that I work with. I have what’s called a “micro business”, us micro business owners work alone or have up to three employees. I even belong to a group called “Tiny Business/Mighty Profits”, we’re all in the same boat–we own tiny businesses and hope to earn mighty profits. We’re like the silent majority of the business world, we’re out there in great numbers but we are not who Congress is catering to with their tax bills.

Congress generally considers small businesses to have 100 employees or less. There are different standards for different industries. For example my industry is tax preparation. According to the standards set forth by the U.S. Small Business Administration, to qualify as a small business, a tax preparation service’s annual receipts must be $7 million dollars or less. I’m definitely in the “or less” category.

For us micro business owners, most of the legislation allowing increased deductions for new equipment and research and development won’t be affecting us. We’re not big enough to even reach the limits that were already available.

But the small business bill does throw a bone to us little guys! Now, we can write off our health insurance as an expense against our business income. We’ve been able to take a deduction for our health insurance to offset our regular income in the past, but now our health insurance reduces our self employment tax. Last year, I paid $6,000 for my private health insurance. Self employment tax is 15.3%–that would save me $918 on my health insurance. Woo Hoo!

The best part–this new rule is retroactive for the 2010 tax season.  The worst part, is it’s only good for the 2010 tax season.  It may be a one shot wonder, but take it while you can get it.