Tag: small business

Posted on by Jan Roberg

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.

 

Posted on by Jan Roberg

Business or Hobby?

Hobby or business?

                                                               Photo of life size action figures at a gaming event in Thailand.

 

Updated December 6, 2018

Batman stopped by my office the other day.  He usually doesn’t visit me in his Bat costume, but he had just done a charity fundraiser as Batman and had promised  the ladies in my office to visit us in costume.  (I’d just like to point out that not all of my friends and clients are super heroes.  I do know plenty of normal people.)

 

I once did a post about a fellow who made a business out of appearing as Superman.  On a good day, Superman can take in some decent money.  After Batman’s successful fundraiser, he kind of wondered aloud about following in Superman’s footsteps and making occasional appearances for pay also.  While I recently made the case for Superman being a legitimate business, Batman’s income I believe would be a hobby.

 

How do you tell if something is a business or a hobby?  Sometimes it’s kind of hard to tell.  Everybody recognizes that if you open up an Ace Hardware store selling tools and duct tape you’ve got yourself a real business.  But what if you make purses and wallets out of duct tape and sell them at craft fairs?  Where does that fit in?  What if you breed your champion Cocker Spaniel and sell the puppies?  Dog breeding is a real business, but how many litters makes you a breeder?  It’s not all black and white.   Here are some guidelines to help you.

 

First, I want to point out the most important key ingredient that the IRS uses to determine if you are a real business:  a 1099MISC showing an amount under “non-employee compensation.”  There are numerous guidelines as to what constitutes a business versus a hobby and this one is never mentioned.  Yet it’s the most important factor as far as the IRS is concerned!  If you receive a 1099MISC, the IRS counts that as self-employment and they will tax you not just income tax, but an additional 15% self employment tax.  As a professional preparer, if I see one of those, even if I truly believe that your business should be classified as a hobby, I’m preparing a Schedule C showing you as a business.   That’s how the IRS is treating that income.

 

What’s the difference in how your income is classified and why is it important?  Business income is taxed at your regular income tax rate plus the self employment tax rate.  Let’s say your regular tax rate is 22%, then your business income is taxed at 37% (22% + 15% = 40%.)   The advantage of being treated as a business is that you can write off your direct business expenses against the income and you can even have a loss that will offset your other income.

 

Hobby income is taxed at your regular tax rate, there is no self employment tax so you pay less tax on hobby income.  The big disadvantage to claiming income as hobby income is that under the new tax law for 2018, you can’t deduct your Hobby expenses.  (Although to be fair, it wasn’t a very good deduction before 2018 anyway.)

 

You cannot switch your business back and forth from hobby to business depending upon whether or not you have a profit or loss.  It’s okay to grow your hobby into a business.  It’s even okay to downgrade your business into a hobby.   But flip flopping for the sake of lowering your taxes is just going to land you in trouble with the IRS.  You need to put a little thought into it before you start claiming business losses.

 

If you’re not receiving 1099 MISC forms, what other tests can you use to prove your business is real and not a hobby?  One is the three year test–if you’ve shown a profit in three out of the past five years, then you’re considered a business.  This is a good rule, but it’s not completely hard and fast.  There are court cases proving businesses to be valid even though they’ve shown losses for more than three years.  Even though its a good rule of thumb, I don’t like to see people get too hung up on it, there are other tests.

 

Is the business carried out with the intention to make a profit?  Does the taxpayer (or the taxpayer’s advisors)  have the knowledge to make the business a success?   Does the taxpayer spend enough time on the business to indicate a profit motive?  Has the taxpayer made a profit on similar activities in the past?   The answers to these questions is why I put Superman in the business category and not the hobby category.  Superman had previous paid experience as a costumed character and model, and he also had a website devoted to his business and posted blogs about how to be a superhero.  He clearly devotes a great deal of time to his business.   Batman,on the other hand, wouldn’t really pass these tests, that’s why I consider his income to be hobby income.

 

Me with my Batman friend back in 2010

One final point.  Batman takes offense at Batman being labeled as a hobby.  “Batman isn’t a hobby, it’s a calling.”  Like I said in the beginning, some of my friends are normal.

 

Posted on by Jan Roberg

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

Posted on by Jan Roberg

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.

Posted on by Jan Roberg

Is a Flu Shot Good for Your Business?

I got my flu shot yesterday and I’m writing it off as a business expense.  I wasn’t going to get one.  I’m reasonably healthy (knock on wood) and I’m not in any of the target groups susceptible to the flu, so I wasn’t going to bother.  What I didn’t know, was that without a flu shot I could be a carrier and infect other people with the flu.  In my business I meet with hundreds of people during the height of flu season.  I don’t want to be responsible for getting any of my clients or their family members sick.

But writing it off as a business expense?  That might seem like a leap, but it’s really not.  Every year when I’m preparing other people’s taxes, I write off all types of vaccinations for health care providers because it’s an ordinary and necessary part of their jobs.  I write off hepatitis vaccinations for people in the food industry because it’s an ordinary and necessary cost of working with food.

The key phrase here is “ordinary and necessary.”  It’s a term the IRS uses a lot in their small business publications.   I honestly believe that protecting my clients from a potential life threatening illness is an ordinary and necessary part of my business.  If you work with people, especially if you deal with senior citizens or children,  protecting them is indeed ordinary and necessary.   Therefore, in my professional opinion, a flu shot is a legitimate business expense.

One final thing, much to my surprise — it didn’t hurt!