In 2018, once your income subject to Social Security tax hit $128,400 (this is usually higher than your income subject to Federal tax, due to various exclusions such as 401k contributions that are subject to SS tax but not income tax) they stopped taking Social Security tax out of your paycheck.
This results in, sometime late in the year (the more you make the sooner it happens) a de facto 6.2% raise in your paycheck (which is effectively tax free). Many people don't notice it. Others notice it, but don't realize what it is.
The important thing to know is:
Beginning in January they start taking it out again.
So goodbye to that raise!
Realizing what's happening and managing it can help avoid a fiscal shock in January (just when the holiday bills are coming due as well). I advise my clients in this income range to pay attention to this and use the money "off-budget". Meaning to save it, invest it, or use for one-time expenditures like a vacation or a home remodel.
People unconsciously raise their standard of living as their income increases. Understanding how this happens and taking conscious control of it is one of the keys to financial success. This example is just one area where it matters.
Take control.
Understand your income and expenditures.
Be aware of "found" money like this.
And understand that you are about to take a "pay cut."
Showing posts with label tax deduction. Show all posts
Showing posts with label tax deduction. Show all posts
Monday, December 31, 2018
Wednesday, July 19, 2017
Real Estate Agent Tax Guide
This is a pretty comprehensive guide for the new real estate agent. It doesn't cover everything, but it will get you started in the right direction. I update it at least once a year to keep it up to date.
UPDATED for the Trump/GOP Tax Law in January 2019!
So you've got your real estate agents license and that first commission is finally on the way. No way around it now, you have taxable income. The question is, how much? And, how do you pay as little as possible? This post assumes that you will be paid on a 1099-MISC, as a self-employed Real Estate Agent. If you're getting a W-2, some of this will be useful, but not all. I'm also assuming that you work for a real estate company, and aren't completely independent. Much of this advice isn't gospel, it's just what I've seen and think works best. In some ways, it's a list of "best practices." As always, you should use this post as a starting point, and seek professional assistance when it comes to your personal situation. I am also going to assume you have not formed a complex business entity such as an S Corporation or Multi-Member Limited Liability Corporation. There are benefits and disadvantages to these, but you need to talk to a professional to understand them.
Here's a bit of something you might not want to hear, but it's actually good news. Here we go: The goal of being a real estate agent is to make tax time SUCK. If you are doing this thing right, you will owe a lot of money, every year, and the amount will go up, every year. The reason is that you are making more money. It's easy to pay no taxes if you are a crappy agent who can't make money. The goal is to make a CRAP-TON of money and pay a CRAP-TON of taxes. The key is to make sure you are prepared for the taxes you owe, and to keep the amount to the minimum legally allowed. I tell my clients that if they are doing things right they should hate me.
A great gift for buyers would be a copy of my tax book. It's based on life events and has chapters like, I'm Getting Married, I'm Having a Child and, wait for it...I'm Buying a House! Please consider buying a ton and giving them to your new homeowners - they'll thank you!
Now let's cover some more details:
If you are an experienced Real Estate Agent, help make this better by emailing me with any best practices you use, or anything I might have missed. Feel free to leave a tip if this helps you save a bunch of money on your taxes!
UPDATED for the Trump/GOP Tax Law in January 2019!
So you've got your real estate agents license and that first commission is finally on the way. No way around it now, you have taxable income. The question is, how much? And, how do you pay as little as possible? This post assumes that you will be paid on a 1099-MISC, as a self-employed Real Estate Agent. If you're getting a W-2, some of this will be useful, but not all. I'm also assuming that you work for a real estate company, and aren't completely independent. Much of this advice isn't gospel, it's just what I've seen and think works best. In some ways, it's a list of "best practices." As always, you should use this post as a starting point, and seek professional assistance when it comes to your personal situation. I am also going to assume you have not formed a complex business entity such as an S Corporation or Multi-Member Limited Liability Corporation. There are benefits and disadvantages to these, but you need to talk to a professional to understand them.
Here's a bit of something you might not want to hear, but it's actually good news. Here we go: The goal of being a real estate agent is to make tax time SUCK. If you are doing this thing right, you will owe a lot of money, every year, and the amount will go up, every year. The reason is that you are making more money. It's easy to pay no taxes if you are a crappy agent who can't make money. The goal is to make a CRAP-TON of money and pay a CRAP-TON of taxes. The key is to make sure you are prepared for the taxes you owe, and to keep the amount to the minimum legally allowed. I tell my clients that if they are doing things right they should hate me.
I'm going to start with some basics, and then get into details. The first big surprise you will have is that nobody's taking taxes out of your paycheck. You have to pay it all as you go, or at the end of the year when you file your tax return. The second thing is that there's nobody to pay for Social Security taxes except, well, you. Most people are barely cognizant of the 7.65% that's taken right off the top of a normal paycheck for Medicare and Social Security taxes. What even the most aware don't realize is that their employer matches this deduction! As a 1099 recipient (self-employed is the IRS term) you have to pay both the employee and employer portion! This means a 15.3% additional tax! Imagine you're in the 12% tax bracket - that means you actually pay 27.3% taxes! And this doesn't even cover state taxes! Also, you don't want to be in the 12% tax bracket - you want to make more money and end up in the 22% or higher bracket!
The good news is that, unlike a W-2 employee, you only pay these taxes on your 'net' income. This means you get to take all "ordinary and necessary" expenses off the top before you pay a dime in taxes. So what is 'ordinary and necessary'? I like to boil it down into two categories: 1 - things you pretty much have to pay - like licensing, commissions and fees. 2 - things you pay because you expect them to increase your income or make the business run more efficiently. If they meet either of these requirements, they're pretty much a lock as being deductible.
Knowing the above, it's important that I give one of my biggest pieces of advice - you pretty much should NEVER do something just because you expect it to help on your taxes. Spend money only if you have to, or because it's the best idea for your business! This has two benefits: 1 - you don't waste money on stupid s**t. 2 - chances are the deduction is legitimate.
So now comes the part you've been waiting for: What the hell can I deduct? Here's a non-exhaustive list, with some details, to get you started:
Marketing Expenses: Business cards, website fees, MLS dues, lead generating expenses, posters, signs, sponsorships, commercials, advertising, pretty much anything you do to get someone to call YOU when they want to buy or sell a house. As a non-tax aside, you need to evaluate these carefully and talk to experienced agents to find the best of these. Your commissions are big but come infrequently. You need to understand how much you spend for each commission so you can properly evaluate what works best.
Gifts and Referral Rewards: Gifts to clients are generally limited to $25 per person, per year. (That’s the deductible amount, you can give more.) Be careful of referral fees. You should have received more training on this than me to get your license, but I will simply remind you that there are varying rules from state to state, as well as RESPA requirements that restrict what amounts, how and to whom you may pay a referral fee, so, check with your senior brokers before paying these. If the referral fees are legal, there are ways to deduct them, but talk to your tax professional about them.
Gifts and Referral Rewards: Gifts to clients are generally limited to $25 per person, per year. (That’s the deductible amount, you can give more.) Be careful of referral fees. You should have received more training on this than me to get your license, but I will simply remind you that there are varying rules from state to state, as well as RESPA requirements that restrict what amounts, how and to whom you may pay a referral fee, so, check with your senior brokers before paying these. If the referral fees are legal, there are ways to deduct them, but talk to your tax professional about them.
A great gift for buyers would be a copy of my tax book. It's based on life events and has chapters like, I'm Getting Married, I'm Having a Child and, wait for it...I'm Buying a House! Please consider buying a ton and giving them to your new homeowners - they'll thank you!
Training, Education, and Licensing: Whatever you pay to maintain your ability to be an agent is deductible, as well as things you do to increase your skills, as well as what you are allowed to do in the field. Classes, seminars, books, and certificates mostly all qualify.
You could deduct this book - which will also help you make more money in your business:
EntreLeadership: 20 Years of Practical Business Wisdom from the TrenchesYou could deduct this book - which will also help you make more money in your business:
Insurance: I'm not talking about homeowners insurance here. I'm talking about ‘oops I screwed up and my client is suing me insurance’; or someone who's not my client. Sometimes this is called Errors and Omissions Insurance. If your state or agency doesn't require it, get it anyway! 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.)
Entertainment Expenses: Eventually you'll be with a client, or potential client, and pick up the tab for lunch, or dinner, or a stripper (don't do that - it's tacky - and questionable as a deduction). 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) 50% of the meal (and ONLY the meal) is deductible. I recommend writing the name of the client on the receipt, as well as a quick description - "house hunting", "referral source", "potential client" or something like that.
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 go to dinner with a client that is moving to your area, the trip is primarily personal. You can deduct expenses DIRECTLY RELATED to the meeting with the client, 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 real estate 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.
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!
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 write 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 track this. It is a mobile phone app that AUTOMATICALLY tracks your mileage every time you drive. Then a simple swipe categorizes it as business, personal, medical or charity. You can add notes to each trip and print a report for filing taxes. It even keeps a running total of your deduction amount! It costs a small amount to use (which is deductible) but is a MUST!
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!)
Employer Reported Expenses: In many cases, your employer is going to charge you for a number of different things like marketing and insurance. They will generally track the expenses and then deduct them from your commission check when you make a sale or broker a purchase. Virtually everything they charge you for will be deductible, but they will report the full amount of your commission on the 1099-MISC at the end of the year, and then give you a report of what they charged you. This simplifies things for record keeping, except that you need to make sure not to deduct something from the employer report twice by tracking it in your own records.
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 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.
Now let's cover some more details:
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 usable. I hate double-entry bookkeeping and would never recommend it as a tool for a Real Estate Agent. 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 for Real Estate Agents involves a small notebook, a big notebook and an envelope or box. The small notebook is for mileage, discussed above. The big notebook is for every other expense (except employer reported expenses.) You need simple columns set up: date, expense, and cost. 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.
Separate Bank Account: This one might be a little controversial, but I believe it's the be all end all of successful businesses. Combined with record keeping discussions above, and budgeting discussions below, this will make everything easier. Open a separate bank account for your Real Estate Agent business. It doesn't have to be in a different name, just separate from your personal account. If you use credit, get a second credit card that is exclusively for business (again, it doesn't have to actually be a business credit card, just one that you use only for business). Put all Real Estate income in this account, and pay all Real Estate expenses out of it, or with the business credit card. Pay off the business credit card out of this account. The only expenses not paid out of the account are car expenses (especially gas) and home office expenses that will be divided based on square footage as discussed under home office above (utilities would not be paid out of the account, but office supplies and business only cell phone would). The beauty of this method is that it simplifies budgeting as we'll discuss below, and it allows reconciling of expenses to make sure your notebook covers everything. A good tax expert should be able to compare your account statements with your notebooks and know if you missed something (assuming you don't intermingle personal and business expenses).
Budgeting and Saving: Now that you have an account that is separate for business, you can start thinking about budgeting. Your income is going to fluctuate wildly, so you can use the business account to pay a "salary" to your personal account. I recommend letting some money build up in the business account until you have a feel for your income level. It will probably start small, but build up over time. Once you have a good feel, you can pay yourself this salary. The salary should be no more than 50% of your gross income or 60% of your net income. You need to play around with it. Start small and raise it if income exceeds expectations, but NEVER pay yourself more than 60% of net income. Having a salary allows you to budget like you had a normal job. Keeping a buffer amount in the account allows you to have a "salary" even during lean months. By paying yourself a salary and saving the rest, if you have a really big month, you end up saving more, which in turn allows you to have the money to pay the tax bill that the big month will generate. When you file your taxes, you should have plenty of money to pay the tax bill, and still have money left to maintain a buffer, and, if you're lucky, have the ability to pay yourself a bonus to your personal account for a big purchase or vacation!
Estimated Payments: My advice is that you should use the budgeting advice above to pay your taxes. You'll still need to make estimated tax payments if you're making good money, but you should pay the minimum required to avoid an underpayment penalty. Your tax advisor will calculate them for you, but to explain simply: you need to pay at least as much as your prior year's total tax liability in withholding or estimated taxes to avoid a penalty (oversimplified explanation, but really all you need to know). This is an easy calculation for your tax guy and he will set up quarterly payments and provide vouchers for paying them. (The timing is a little weird. You pay 4/15, 6/15, 9/15 and 1/15.) You can also pay varying payments to try to avoid a tax bill, but it gets complicated, and the government won't pay you interest.
The "Pass-Through" deduction: Your business almost certainly qualifies for this deduction, even if it is a sole-proprietorship and not a fancy S-Corp or LLC. This means you can generally deduct 20% of the profits from your business off of taxable income (but the ~15% self employment tax would still apply). If the taxable income (income after all deductions except this one) is less than (2018 numbers - these go up every year) $157,500 or $315,000 if you are Married Filing Jointly (MFJ), then that's all there is. If you are above that, you are subject to two limitations, one, because you are a service oriented business (you make money based on your knowledge) the deduction phases out over the next $50,000 of income increase ($100,000 if MFJ). The other limits your deductions based on wages you pay (even to yourself) and things you are depreciating. This is a complicated topic, so see a pro if your situation is complicated. I suspect most software will handle it nicely if you are below the income thresholds discussed above. As you make more money and start approaching the income limits discussed above, it's imperative that you start seeking advice from a competent EA (Enrolled Agent) or CPA and prepare for the incredible complexities of being a high income real estate agent. There are a lot of things you can do to mitigate taxes at these levels and you WILL need help with them.
The "Pass-Through" deduction: Your business almost certainly qualifies for this deduction, even if it is a sole-proprietorship and not a fancy S-Corp or LLC. This means you can generally deduct 20% of the profits from your business off of taxable income (but the ~15% self employment tax would still apply). If the taxable income (income after all deductions except this one) is less than (2018 numbers - these go up every year) $157,500 or $315,000 if you are Married Filing Jointly (MFJ), then that's all there is. If you are above that, you are subject to two limitations, one, because you are a service oriented business (you make money based on your knowledge) the deduction phases out over the next $50,000 of income increase ($100,000 if MFJ). The other limits your deductions based on wages you pay (even to yourself) and things you are depreciating. This is a complicated topic, so see a pro if your situation is complicated. I suspect most software will handle it nicely if you are below the income thresholds discussed above. As you make more money and start approaching the income limits discussed above, it's imperative that you start seeking advice from a competent EA (Enrolled Agent) or CPA and prepare for the incredible complexities of being a high income real estate agent. There are a lot of things you can do to mitigate taxes at these levels and you WILL need help with them.
I hope you find this advice useful. If you keep good records and separate personal and business expenses you'll make your tax guy's job easier, and pay the minimum in taxes. If your tax guy sighs a lot while viewing your records, try harder next year.
If you are an experienced Real Estate Agent, help make this better by emailing me with any best practices you use, or anything I might have missed. Feel free to leave a tip if this helps you save a bunch of money on your taxes!
As always, I’m available to answer questions at taxadvisor@email.com. You might get a reply from a slightly different email address – that’s my phone. It knows taxes better than I do so sometimes I let it respond!
Don't rush off! I have a lot of other cool posts:
http://supertaxgenius.blogspot.com/2016/01/master-index-of-posts.html
Buying from the Amazon links supports this blog! Thanks!
Don't rush off! I have a lot of other cool posts:
http://supertaxgenius.blogspot.com/2016/01/master-index-of-posts.html
Buying from the Amazon links supports this blog! Thanks!
Thursday, March 10, 2016
UBER Driver Tax Guide
If you like the blog, buy my books: Kirk Taylor, EA Author Page
This Tax Guide is written with very specific information for UBER drivers of all types. It can be used by LYFT and other casual taxi drivers, but may not have enough information for true professional non-web based taxi drivers.
Most clients I see trying these businesses out have not given a thought to taxes, but UBER does a fairly good job of helping out. The year end statement you receive has a wealth of useful information. That said, there are a lot of deductions that aren't included that are a slam dunk, as well as some others that might be more shaky. As with all new business models, a lot of how these things apply specifically to UBER have not been fought out with the IRS, so some things may evolve over time. I'm going to start with a general discussion of things that every UBER driver should understand about taxes, and then get into the specifics of your documentation, and then get really specific on deductions.
First, some things you should know and understand:
1. Your business model is a bit unique, and you're doing some things that are fairly common in the tax world, but on a much higher scale than normal. You're using your own car for business, but the business side may be a very small percentage (or very large) of the use of your car. Your car is now a business asset (in part) and thus there are potential implications when you buy, sell or trade it. Keep things simple by only using one vehicle at a time, and taking the standard mileage rate (discussed later).
2. 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. If your spouse or partner also drives for UBER, they will have a separate and independent business, with it's own schedule C, and, hopefully, their own car. Co-mingling cars at this point will greatly complicate your taxes and probably seriously confuse your, or your preparer's, tax software.
3. 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. Based on the returns I've done so far, the more you drive, the more likely it is that you will also generate taxable income after expenses. This income will be taxed at a much higher rate. 15.3% minimum for self employment taxes (the self-employed person's Social Security and Medicare). The good news is, you only pay taxes on the profit. We'll talk more about budgeting for taxes later.
4. You might not actually be a business. There's some tension between Hobby and Business income. If you take losses year after year, the IRS may 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. UBER recruiting has not helped with this, as they sell it more like a Hobby than a Business. As a Hobby, 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.
Moving along. Here's the advice you need to make things work...
Income: This is the easy part. UBER will issue you a 1099-K and (maybe) a 1099-MISC. The 1099-K reports the income from all the rides you gave and the 1099-MISC reports all other income. You just need the totals from these, though some software lets you enter the whole form and pulls the relevant data. Box 1a of the 1099-K and Box 7 of the 1099-MISC is your Gross Receipts for your Schedule C. I've seen UBER drivers that took tips, and others that did not. If you get tips, add them to these amounts. Any other income you make as a driver should also be added, but I think UBER frowns on this.
Record Keeping: This is usually the biggest deal for a small business, but for UBER it should be very simple. Keep a mileage log!!!!! We will discuss mileage below but, know this, the one piece of information from UBER you should ignore is the mileage number - this is where you will save the most in taxes. (Mile IQ is AWESOME for this)! Other than that, have a notebook and an envelope for receipts. When you make a purchase for the business, write down date, description and cost, if you get income not tracked by UBER, add it here as well. Throw the receipt in the envelope. 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. That's it. 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, notebook, mileage log and tax returns for 7 years, and then throw it all away. If you ever 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. You get money, it’s entered as income, you pay money, it’s entered as a deduction.
Keep in mind that UBER will report every penny you make, and then give you a report of deductions they took off. This is the easy part. For a lot of people, especially casual drivers, these will be all the deductions they have - except for the mileage log that you MUST have. You can use UBER's mileage, but you'll be leaving your best deduction on the table (or in the car!)
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. The list below is actually a fairly exhaustive list of normal business deductions, tailored to UBER. Some won't apply at all, but I'm leaving them there to stimulate your own thoughts.
First some things most UBER driver's could or should be deducting (details in the numbered lists): Mileage, any tolls, parking or access fees not included in the UBER statement, driving gloves, insurance riders, office supplies for the business, steering wheel covers, car equipment specifically for driving passengers that is not normal car equipment or maintenance, mileage tracking apps or equipment, business cards, commercial driver's license, car seat additions that help for long driving, and a percentage of cell phone bills if you use your cell phone for the UBER app. Also any safety clothing or equipment that would not be considered normal for a car that was not used for driving paying passengers. Examples might be first aid kit, flares, fire extinguisher, or a reflective vest. Some might argue that these are normal for a regular driver, but how many people do you know that have these in their car? I would deduct them.
Second, things you should not be deducting: Car maintenance including car washing, oil changes, gas, repairs or any other vehicle expenses unless they are specific alterations or additions to allow you to drive commercially (the mileage deduction covers all these things). Meals and entertainment would be unlikely. Uniforms or clothing would not be deductible, though possibly dry cleaning of a specific set of "driving clothes" - this would be shaky.
Here's the 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). These are all the deduction numbers listed on your annual UBER tax summary (except the income, of course). They generally fit into nice categories on your Schedule C, mostly as commissions.
This Tax Guide is written with very specific information for UBER drivers of all types. It can be used by LYFT and other casual taxi drivers, but may not have enough information for true professional non-web based taxi drivers.
Most clients I see trying these businesses out have not given a thought to taxes, but UBER does a fairly good job of helping out. The year end statement you receive has a wealth of useful information. That said, there are a lot of deductions that aren't included that are a slam dunk, as well as some others that might be more shaky. As with all new business models, a lot of how these things apply specifically to UBER have not been fought out with the IRS, so some things may evolve over time. I'm going to start with a general discussion of things that every UBER driver should understand about taxes, and then get into the specifics of your documentation, and then get really specific on deductions.
First, some things you should know and understand:
1. Your business model is a bit unique, and you're doing some things that are fairly common in the tax world, but on a much higher scale than normal. You're using your own car for business, but the business side may be a very small percentage (or very large) of the use of your car. Your car is now a business asset (in part) and thus there are potential implications when you buy, sell or trade it. Keep things simple by only using one vehicle at a time, and taking the standard mileage rate (discussed later).
2. 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. If your spouse or partner also drives for UBER, they will have a separate and independent business, with it's own schedule C, and, hopefully, their own car. Co-mingling cars at this point will greatly complicate your taxes and probably seriously confuse your, or your preparer's, tax software.
3. 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. Based on the returns I've done so far, the more you drive, the more likely it is that you will also generate taxable income after expenses. This income will be taxed at a much higher rate. 15.3% minimum for self employment taxes (the self-employed person's Social Security and Medicare). The good news is, you only pay taxes on the profit. We'll talk more about budgeting for taxes later.
4. You might not actually be a business. There's some tension between Hobby and Business income. If you take losses year after year, the IRS may 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. UBER recruiting has not helped with this, as they sell it more like a Hobby than a Business. As a Hobby, 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.
Moving along. Here's the advice you need to make things work...
Income: This is the easy part. UBER will issue you a 1099-K and (maybe) a 1099-MISC. The 1099-K reports the income from all the rides you gave and the 1099-MISC reports all other income. You just need the totals from these, though some software lets you enter the whole form and pulls the relevant data. Box 1a of the 1099-K and Box 7 of the 1099-MISC is your Gross Receipts for your Schedule C. I've seen UBER drivers that took tips, and others that did not. If you get tips, add them to these amounts. Any other income you make as a driver should also be added, but I think UBER frowns on this.
Record Keeping: This is usually the biggest deal for a small business, but for UBER it should be very simple. Keep a mileage log!!!!! We will discuss mileage below but, know this, the one piece of information from UBER you should ignore is the mileage number - this is where you will save the most in taxes. (Mile IQ is AWESOME for this)! Other than that, have a notebook and an envelope for receipts. When you make a purchase for the business, write down date, description and cost, if you get income not tracked by UBER, add it here as well. Throw the receipt in the envelope. 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. That's it. 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, notebook, mileage log and tax returns for 7 years, and then throw it all away. If you ever 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. You get money, it’s entered as income, you pay money, it’s entered as a deduction.
Keep in mind that UBER will report every penny you make, and then give you a report of deductions they took off. This is the easy part. For a lot of people, especially casual drivers, these will be all the deductions they have - except for the mileage log that you MUST have. You can use UBER's mileage, but you'll be leaving your best deduction on the table (or in the car!)
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. The list below is actually a fairly exhaustive list of normal business deductions, tailored to UBER. Some won't apply at all, but I'm leaving them there to stimulate your own thoughts.
First some things most UBER driver's could or should be deducting (details in the numbered lists): Mileage, any tolls, parking or access fees not included in the UBER statement, driving gloves, insurance riders, office supplies for the business, steering wheel covers, car equipment specifically for driving passengers that is not normal car equipment or maintenance, mileage tracking apps or equipment, business cards, commercial driver's license, car seat additions that help for long driving, and a percentage of cell phone bills if you use your cell phone for the UBER app. Also any safety clothing or equipment that would not be considered normal for a car that was not used for driving paying passengers. Examples might be first aid kit, flares, fire extinguisher, or a reflective vest. Some might argue that these are normal for a regular driver, but how many people do you know that have these in their car? I would deduct them.
Second, things you should not be deducting: Car maintenance including car washing, oil changes, gas, repairs or any other vehicle expenses unless they are specific alterations or additions to allow you to drive commercially (the mileage deduction covers all these things). Meals and entertainment would be unlikely. Uniforms or clothing would not be deductible, though possibly dry cleaning of a specific set of "driving clothes" - this would be shaky.
Here's the 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). These are all the deduction numbers listed on your annual UBER tax summary (except the income, of course). They generally fit into nice categories on your Schedule C, mostly as commissions.
2. Marketing Expenses: I'm thinking most of this will be handled by UBER, but if you spend money for business cards, signage, websites, etc, these will be deductible. I'm guessing you might have some for finding new drivers for UBER and getting the referral fee, though I'm not sure you should be recruiting your own competition.
3. Insurance: I'm not talking about homeowners insurance here. I'm talking about ‘oops I screwed up and someone is suing me insurance.’ There's a lot of argument right now as to whether your personal car insurance is good enough for the business, and I'll provide a link to an article on the subject below this comment. That said, if you have just regular, personal car insurance - no deduction. If you pay extra for commercial insurance, or a rider for commercial use, or a special 'UBER' rider that some companies are providing, that cost is deductible.
4. Entertainment and Meal Expenses: You really shouldn't have any of these. Your meals aren't deductible, even when waiting for a customer. I also can't really envision you taking someone to lunch. Since UBER provides the customers, this is a no-go. Some drivers have had mints or such in the car - I call those supplies (and they are deductible). I guess theoretically you might take a potential driver to lunch to talk to them about driving for UBER in hopes of getting the referral fee. In that case, save the receipt and write the persons name, and the topic of discussion on the receipt. That would be deductible entertainment expense - don't abuse this.
5. Travel Expenses: Unless UBER starts running those educational seminars that the IRS hates, you won't have much of this. I guess theoretically, you might drive to a big metropolis for a special event so you can make boatloads of money, so I guess we'll talk about it. If you travel specifically to drive and make money for UBER, you can deduct airfare (though how would you get your car there), car rental (I guess you could rent a car and drive it, but I'll bet that violates a lot of terms of use), lodging, mileage, meals, tips, tolls and other necessary travel expenses. For meals you can take a standard Federal daily rate for the area you are in (google 'per diem rates' and you'll find a list). If the travel is not 100% for business - like you visit family and do a few rides, or drive to Vegas or New York City for a long weekend and some shows, and do some driving while you're there - it gets complicated. You can take a portion of the travel based on the percentage of time spent "on the clock" for UBER.
6. Cell phones, laptops and tablets: You can take a portion of the phone and data costs for the phone you use for UBER. Ratio based on time or data usage. Don't go crazy figuring the exact ratio. If you do a lot of driving, or it's your main source of income, you may want to get a business only phone, and/or laptop. You can take a portion of your personal stuff, but it might not be worth it unless the ratio is high. We'll talk about business use of home later. The purchase of laptops or phones that you use for business generally requires them to be depreciated (taking a portion every year for several years.) Your tax professional or software should handle this, but make sure you put the information in right.
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! UBER only tracks miles with passengers. If you're "on the clock" driving around waiting for a call, driving to or from a pickup, or driving to do other things to support your business - write it down! You pretty much get no other deductions for the vehicle, but the mileage deduction is very generous.
8. Home Office: If your business is getting big, 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, and do other business related things. 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. Licenses: If you get a commercial driver's license, that is deductible. If you have to pay for special licenses, tags, access fees or other things to let you pick up passengers in an area or work in an area, those are deductible. UBER pays some of these for you and accounts for them on your statement, so don't double deduct!
11. Taxes: Unlikely, but sales or other taxes may come into play in some super psycho jurisdictions. UBER should handle this, but don't assume they do. 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.
Do I need a Separate Bank Account? This one might be a little controversial, but I believe it's the be all end all of successful businesses. Once your business really gets going, and is more than just a little side income, it's this, combined with record keeping discussions above, and budgeting discussions below, this will make everything easier. Open a separate bank account for your business. It doesn't have to be in a different name, just separate from your personal business. If you use credit, get a second credit card that is exclusively for business (again, it doesn't have to actually be a business credit card, just one that you use only for business). Put all business income in this account, and pay all business expenses out of it, or with the business credit card. Pay off the business credit card out of this account. The only expenses not paid out of the account are car expenses (especially gas) and home office expenses that will be divided based on square footage as discussed under home office above (utilities would not be paid out of the account, but office supplies and business only cell phone would). The beauty of this method is that it simplifies budgeting as we'll discuss below, and it allows reconciling of expenses to make sure your notebook covers everything. A good tax expert should be able to compare your account statements with your notebooks and know if you missed something (assuming you don't intermingle personal and business expenses).
How do I Budget if my Income goes up and down? Now that you have an account that is separate for business, you can start thinking about budgeting. Your income may fluctuate wildly, so you can use the business account to pay a "salary" to your personal account. I recommend letting some money build up in the business account until you have a feel for your income level. It will probably start small, but build up over time. Once you have a good feel, you can pay yourself this salary. The salary should be no more than 50% of your annual gross income or 60% of your net income (divide it by twelve obviously, to get the monthly amount). You need to play around with it. Start small and raise it if income exceeds expectations, but NEVER pay yourself more than 60% of net income. Having a salary allows you to budget like you had a normal job. Keeping a buffer amount in the account allows you to have a "salary" even during lean months. By paying yourself a salary and saving the rest, if you have a really big month, you end up saving more, which in turn allows you to have the money to pay the tax bill that the big month will generate. When you file your taxes, you should have plenty of money to pay the tax bill, and still have money left to maintain a buffer, and, if you're lucky, have the ability to pay yourself a bonus to your personal account for a big purchase or vacation!
Do I need to make Estimated Payments? My advice is that you should use the budgeting advice above to pay your taxes. You'll still need to make estimated tax payments if you're making good money, but you should pay the minimum required to avoid an underpayment penalty. Your tax advisor will calculate them for you, but to explain simply: you need to pay at least as much as your prior year's total tax liability in withholding or estimated taxes to avoid a penalty (oversimplified explanation, but really all you need to know). This is an easy calculation for your tax guy and he will set up quarterly payments and provide vouchers for paying them. (The timing is a little weird. You pay on 4/15, 6/15, 9/15 and 1/15.) You can also pay varying payments to try to avoid a tax bill, but it gets complicated, and the government won't pay you interest.
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!
Monday, March 17, 2014
Avon, Pampered Chef, Party Lites, Amway, etc. MLM Tax Guide
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.
BTW: If you like the blog, buy my book: Everyday Taxes 2017.
You definetely need The Short Cheap Tax Book for MLM (sequel to The Short Cheap Tax Book for Everyone). Available NOW! Just click the title. 99 cents for Kindle - which makes all the links functional and easy to use. If you don't have a Kindle, Amazon has a free cloud reader so you can read it on your laptop or tablet - again, the best way to get the most out of it.
I've set up some office hours to answer questions. You can arrange a call or email HERE
For information on the new tax law, which has a ton of impact starting in 2018 on your business, see The Short Cheap Tax Book for the Trump/GOP Tax Law.
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).
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)
BTW: If you like the blog, buy my book: Everyday Taxes 2017.
You definetely need The Short Cheap Tax Book for MLM (sequel to The Short Cheap Tax Book for Everyone). Available NOW! Just click the title. 99 cents for Kindle - which makes all the links functional and easy to use. If you don't have a Kindle, Amazon has a free cloud reader so you can read it on your laptop or tablet - again, the best way to get the most out of it.
I've set up some office hours to answer questions. You can arrange a call or email HERE
For information on the new tax law, which has a ton of impact starting in 2018 on your business, see The Short Cheap Tax Book for the Trump/GOP Tax Law.
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.
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!
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!
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