This is a Tax Guide for all the would be home-based business millionaires. The time to think about taxes is before you open the business, but, if you already have, the time is now! This guide will tell you virtually everything you need to know about how taxes should, and do, work for a Multi Level Marketing type business. The kind of business where someone in the business recruits you to sell the products, and, eventually, recruit others into the business. This guide works for Amway, Mary Kay, Avon, Pampered Chef, Herbalife, Isagenix, Scentsy and dozens of others you've never heard of.
Most clients I see trying these businesses out have not given a thought to taxes, and, are getting very little help from the businesses they are making money for. In fact, the first piece of advice I'll give is to ignore virtually everything the company, other associates or friends tell you about how to handle taxes for these businesses. To go further, I'll tell you to ignore every piece of tax information the company provides, except the 1099MISC they issue you (if you gross >$600) and the invoices for the products you buy and sell. You can, and should, keep better and more useful records all by yourself. More on that point later.
First, a couple of terms, some basic advice, and some warnings:
1. You should be, at this point, a sole proprietor. This means that you own and run the business by yourself, with no employees. You will file the business taxes as a part of your personal taxes, usually on a Schedule C. I strongly encourage you not to have any partners, even your spouse. Your spouse can help, but should generally not be an employee, and not have any true decision making power, except the power that is normal in a healthy spousal relationship (advice and support, but no "official" role). The reasons for this are myriad, and anyone who's delved into a partnership can attest to the issues that arise. For now, just trust me. Later you may want to form a more complicated business entity, but that will require professional assistance and guidance.
2. You are going to spend more time doing taxes, and it's going to cost more. Even if you use software (which I highly discourage if you are running a business) you will pay more for the programs.
3. You might not actually be a business. Most of the people starting these businesses will never have a dime of profit, and, after a few years, the IRS will put the kabosh on taking a negative income from your business off of your regular taxable income. This is called Hobby Income. It means you do it more for fun than for profit. You still have to claim the income (on Line 21 - Other Income), but you deduct the losses on your Itemized Deductions (subject to 2% of income limit, maximum deductions equal to income and a bunch of other restrictions that ensure that you pay taxes on the income instead of getting write offs.) My advice is to go full bore, gung-ho towards making a profit for 3 years. File the Schedule C's and take the losses on your taxes (improving your refund). If, after three years, you haven't made a profit, and gross revenues aren't approaching 5 digits ($10,000), take real stock of where you're at. If revenues are growing and profitability seems close, keep things going. If revenues are flat, profits are a distant dream, and/or your enthusiasm is waning, bite the bullet and either shut the business down, or tone it back and start filing as a Hobby.
4. Some good research and reading can both help you make a profit, and can help win the Hobby vs. Business argument with the IRS. Here are some great books to help you cheaply grow your business:
The Ultimate MLM Boot Camp: How to Succeed in Network Marketing
Guerrilla Marketing, 4th edition: Easy and Inexpensive Strategies for Making Big Profits from Your SmallBusiness
EntreLeadership: 20 Years of Practical Business Wisdom from the Trenches
You can also do some cool, cheap marketing. I assume you have business cards, right? You can make magnets out of them here:
Business Card Magnets
5. The IRS doesn't like your business model. They tend to believe most MLM businesses are actually hobbies. They will scrutinize the line between business and personal expenses. They think pretty much every seminar you attend is a personal expenses. Be very careful to document what you deduct and be prepared to explain how it will actually benefit your business and is not a personal expense.
Moving along. Here's the advice you need to make things work...
Record Keeping: This is where the rubber meets the road. Good record keeping will save you when it comes to tax time. Your records don't need to be extensive, but they do need to be accurate and useable. I hate double entry bookkeeping and would never recommend it as a tool for a home-based business. I also have found that the various bookkeeping software programs are virtually useless when it comes to taxes. They may help when it comes to managing the business, but they suck for doing taxes. The best and easiest record keeping method I've found involves a small notebook, a big notebook and an envelope or box. The small notebook is for mileage, discussed below. The big notebook is for every other expense. You need simple columns set up: date, description, cost and payment received (if you pay something, it goes in the cost column, if you’re paid it goes in the payment received column.). You can add categories, but don't really need to, if you're unsure something's deductible, write it down and let your tax guy tell you if it's deductible. The box/envelope is for receipts - just throw them in. Really? No sorting, categorizing or organizing? No. Simply put, your odds of ever needing them for an audit are slim to none. Save the box, notebooks and tax returns for 7 years, and then throw it all away. If you ever do get audited, there's plenty of time to sort through the box and organize it to match the notebooks - but why do it if it's not necessary. If I'm doing your taxes I'm going to use the notebooks, and remind you that you should have a receipt for everything. You don't have to prove things to me. It’s important to understand not to over think things. For example, if you make a sale involving sales tax, which you know a portion will go to the government, you still write down 100% of what you were paid (including the tax). Later, when you remit the sales tax to the government, it is entered as a payment (deduction.) Get it – you get money, it’s entered as income, you pay money, it’s entered as a deduction.
The trick to your kind of business is that sometimes you don't make the sale, it happens through a website and is fulfilled by the company, with the payment going straight to the company, the product going straight to the consumer, and you getting a commission. Generally the company will only report the commission as income to you, which means you don't need to track any expenses like shipping, sales tax or the wholesale price - just the commission, which you can track when the payment comes to you. Just make sure your company handles it this way, and you'll be good. If the product is paid for by you, comes to you, and then you pass it on to the client for a markup, the entire price paid goes into your records as income, and all the costs to you (shipping, wholesale price, sales tax) go into your records as an expense.
Expenses: You can deduct any ordinary and necessary expenses for your business. I generally describe the requirements like this: If it will make you more money, is required by someone in authority, or makes your business more efficient or your life as a business person easier, it's probably deductible. Here's a non-exhaustive list:
1. Pretty much anything the company charges you for. If they deduct it off your commission check, deduct it off your taxes (you report the gross commission, not the commission after deductions).
2. Marketing Expenses: Business cards, website fees, posters, signs, sponsorships, commercials, advertising, pretty much anything you do to get someone to call YOU when they want your product.
3. Insurance: I'm not talking about homeowners insurance here. I'm talking about ‘oops I screwed up and someone is suing me insurance.’ Sometimes this is called Errors and Omissions Insurance, sometimes it’s a liability bond, or a rider on your homeowner’s insurance. Also, if you pay a rider to your car insurance for business use, the difference between that and regular insurance is deductible. There is also a self employed health insurance deduction that allows you to deduct your health insurance costs if you have no other insurance source (if you can get insurance through your spouse’s work this is a no-go.)
4. Entertainment Expenses: Those party expenses count. The food, the favors, the entertainment. It all counts if you expect there's a chance you'll make money. Eventually you'll be with a client, or potential client, and pick up the tab for lunch, or dinner. Generally, if you expect the expense to result in a sale that makes you money, either immediately, or in the future (whether it ultimately does or not doesn't matter, as long as you expect it to) it's deductible. I recommend writing the name of the client on the receipt, as well as a quick description - "referral source", "potential client" or something like that.
5. Travel Expenses: These are a toughie. People love conflating personal and business travel. If you travel to Maine to visit family and see the lobster festival, and try to sell to some family and friends, the trip is primarily personal. You can deduct expenses DIRECTLY RELATED to the sales efforts, but little else. I recommend keeping business and personal separate. You can visit a friend for dinner on a three day business trip, but don't do business for an hour on a three day personal trip. Also avoid what I call BS travel. Flying to Vegas to assess potential markets is transparent vacationing disguised as business travel, especially if you spend 23 out of every 24 hours in the casino! Be reasonable! Go on trips that are going to increase your money-making potential. Stay away from any others. For legitimate travel, you get airfare, rental car, tips, taxis, laundry, internet and phone, as well as 50% of meals and any other reasonable and necessary expenses. Travel assumes overnight trips away from your home area.
6. Cell phones, laptops and tablets: Do yourself a favor, get a business only laptop, cell phone, tablet and/or computer. It is simply too difficult to calculate expenses on a part personal and part business electronic device. Don't share your business number with friends and family (other than wife and kids). If you keep everything separate, the deductions are easy and legitimate. If you don't, you have to establish a business use percentage, and worry about listed property rules - which suck!
7. Vehicle Expenses: Keep a mileage log. Let me say it again, unless you have a vehicle that is 100%, no s**t, total business and no personal use, keep a mileage log. Don't worry about gas, repairs, oil changes, insurance or any other car expenses (except as discussed above under insurance). There are other ways to track vehicle expenses, but mileage is the best. Do track annual car taxes and finance charges. The easiest mileage log is a notebook where you right the date, the trip purpose and the miles driven. You will also need to know the total miles the vehicle is driven for the year, so write the odometer reading down every January 1st! Mileage will be one of your biggest expenses, so keep track of it religiously! 10,000 miles of properly tracked vehicle mileage can result in $1500 of tax savings! Mile IQ is the absolute best way to do this. It is a mileage tracking app the AUTOMATICALLY tracks every trip, allowing you to very simply identify business vs. personal, and add notes on the purpose. HIGHLY recommend using this!
8. Home Office: Set aside a space in your home that is 100% business use. Never used for anything else, and regularly used for business. This is where you keep your business records, your business computer or laptop, make your sales calls from and meet clients. The tax term is regular and exclusive business use. If you do this, you deduct a percentage of the household expenses - rent, interest, taxes, utilities, insurance, repairs, etc, based on the square footage of the office ratioed to the home square footage. Expenses directly related to the office, such as a dedicated phone line; do not have to be ratioed. You can also take a small depreciation deduction for the home losing value (let your tax guy handle this - it's a b**ch!. The IRS "simplified" this, allowing you to take $5 for every square foot of Home Office, up to $1500, but it's BS to call it simplifying, because any tax guy worth their salt is going to run the numbers both ways and take the number that makes the most sense.
9. Depreciation: Some items that you buy for your business, that have a useful life longer than a year will have to be depreciated over time rather than deducted all at once (examples include computers, digital cameras, machinery, big tools or office furniture). There are many options for deducting it up front, but be wary of this, there are tripwires that can cost you if you dispose of something before it has passed its useful life. Talk about these items with your tax advisor.
10. The stuff you buy to sell: This can get tricky. If everything you sell is paid for and shipped through the company, it's easy, as discussed above about commissions. If you order the stuff, pay for it and either deliver it or ship it to the customer, you have to track the wholesale price, shipping, sales tax and the amount you received. Even worse, if you order items to keep on hand for later sale directly to customers, you need to track all the purchases you made (at your cost is my recommendation) and track what is sold and what is on hand. This is the devil called inventory. You need to know what you have on hand at the beginning and end of the year, what you bought, and what you sold. The easiest way to do this is with an inventory notebook - now you have three. If you buy something, write it down with date, description and price paid. Have columns for date sold, and price sold for, and another column to make a note if it's disposed of without selling it (given away, used by yourself, or expired/lost/stolen. Track each item as it's disposed of, and then, at the end of the year, total everything left - that's Ending Inventory, everything bought during the year - that's Cost of Goods Sold, and everything sold - that's Gross Receipts. Ending Inventory this year becomes Beginning Inventory next year. If you sell some this way and some through the company on commision, you'll have to add commissions to your Gross Receipts, but I think you get the point. If I ran a business like this I would desperately try to avoid inventory, but that might cost you some sales - so - do what works best for you. (BIG UPDATE! After a couple years of comments, and hundreds of emails, I'm waffling on inventory. A lot of scenarios involving display items, demonstrators and personal items can be handled through inventory. Also, since most companies accurately report total purchases, all you need is that number, and the cost of items at the end of each year, and inventory is DONE. Just make sure to use wholesale or retail price for both inventory and purchases. I recommend wholesale. While we're on the subject of the HOURS I spend writing this blog, the only compensation I get is if you BUY MY BOOKS. PLEASE help keep me motivated - here's my author page: amazon.com/author/kirkea)
11. Taxes: Mainly sales taxes. You need to work with your State or County to make sure you collect and remit sales taxes. Don't blow this off. Things get bad. The sales tax you collect and remit is deductible if included in the price you charge, and the income you report. You also may need to pay business taxes and licensing fees to State/County/City. These are deductible, but you need to work these out on your own - this is an income tax guide, and these other taxes vary too much by locale to cover here. Again, don't screw these up. The local governments can be worse than the IRS if you mess up.
There's more that's deductible, but I think you get the idea.TurboTax Deluxe 2014 Fed + Fed Efile Tax Software + Refund Bonus Offer
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Keep the record keeping up to date. It's a nightmare to back fill. Work your ass off to generate business and make money. Research best practices and talk to the people making money doing this. The idea is to MAKE money, and then be pissed off that you are paying taxes on it. Getting a big tax deduction from your unprofitable business is only good at tax time. Paying taxes is a sign of success!