Tax Planning & What Money is Really Yours to Spend?
“In this world nothing can be said to be certain, except death and taxes.” – Benjamin Franklin
Death will only come once, while taxes linger with us year after year.
Many of us spend 2,000+ hours a year working to earn money. Doesn’t it make sense to spend a few hours to learn how to manage it, particularly, when it comes to tax, which is our most expensive lifetime expense?
This blog is offered as a tool to help Independent Contractors & Sole Proprietors avoid tax “surprises” and pro-actively plan their cash flow.
Why Read? Cash Flow – You need to know: What money is really yours to spend?
Many taxpayers were surprised earlier this year when they filed their 2015 tax returns. Why? They were not prepared for the tax affect of having earned what the IRS calls “non-employee compensation”. For example, the 15.3% Self-Employment Tax was an unexpected hit to their cash flow.
Who should read? : (Independent Contractors including Direct Sellers, Freelancers, Airbnb Hosts, Uber & Lyft Drivers, Internet Sellers)
Sole Proprietor: Flying Solo
- Taxpayer is the owner; the business is not separate
- Unlimited exposure to liability
- All debts or claims against the business can be filed against the owners’ personal property
- If the owner is sued, insurance is the only form of protection
- The business itself is not taxed separately; The IRS calls this “pass-through” taxation, because the business Profit and Loss passes through the business to be taxed on your personal tax return
- Tax is based on your personal income level and is taxed at graduated rates
- File your personal income tax on Federal Form 1040 and all business information on Schedule C, Profit or Loss from the business
- Self-Employment tax is required if your annual net-earnings is more than $400
- Net Earnings is determined by tracking both the revenue earned and the corresponding acceptable business expense
What to Do:
Self-Employment requires both basic accounting and additional tax reporting
Maintain a Basic Profit & Loss Statement to determine Net Earnings per Quarter
- A Profit & Loss statement is needed to determine if you owe income tax and self employment tax
- If expenses are less than income, the difference is Net Profit
- If expenses are more than income, the difference is Net Loss
- Losses may be limited on your tax return
- Expense definition may differ for “books” and “tax”
- Tax requires that certain expenses “be capitalized” and expensed over a period of time
IRS Form 1099-Miscellaneous (1099-M)- Income
The Gig Economy is also known as the 1099 Economy because Independent Contractors should receive this form from anyone that has paid them $600 or more during a tax year. The form is sent to both to you and to the IRS. This means, that yes, you need to report the income – even if you did not receive your 1099-M form or if you were paid less than $600 from a single source.
IRS Form 1099-K- shows Income you received through payment processing platforms
- PayPal and other merchants that process payments for your business will issue this form to you & yes, the IRS
- The form is issued in settlement of third-party payment network transactions above the minimum reporting thresholds of $20K in transactions and 200 transactions
- The income reported is the Gross amount of all reportable transactions
- The Gross amount does not include any adjustments for credits, cash equivalents, discount amounts, fees, refunded amounts
- The dollar amount of each transaction is determined on the date of the transaction
- The 1099K only shows income paid to you; it does not include charge backs to your account or fees you paid
- You are responsible for tracking your “income” – you certainly don’t want to pay tax on more than you actually received
Be aware that possible “double reporting” could occur – Reconcile to avoid “overlap”:
- Your clients could issue you a 1099-M and send a copy to the IRS
- PayPal or another vendor could, theoretically, include this same income when they send you a 1099-K
- Although it is not required, it is a good idea to at least review, if not reconcile, what is being reported as “income to you”
- Consider creating a spreadsheet to Cross –Reference payments, for a 1099-M and 1099-K comparison
1099 Income can be reduced by the related “ordinary and necessary” expense
- Receipts and mileage logs must be maintained to support the deduction expense you claim on your tax forms
- Mileage logs should include beginning and ending mileage, where you went, who you saw, and why you went (business purpose)
- Receipts fade. Add notes in ink and then scan to preserve
- Ordinary expense = Common or accepted in your trade or business
- Necessary expense= Helpful or appropriate for your trade or business
- The IRS code provides for allowable deductible expenses and the IRS can take the deductions away if records are not maintained
When: Tax Tips for Filing Requirements:
Federal, State, & Local Tax may need to be paid each Quarter
- The IRS expects you to pay tax as the money is earned. If you operate on a calendar year, due dates are 4/15, 6/15, 9/15, and 1/15 for the previous year
- Quarterly estimated tax payments should be paid if you expect to owe more than $1,000 in federal taxes
- Use 1040ES- Individual Estimated Payments
- Reconcile payments on your annual Year End tax return
- File your federal return on Form 1040 and Schedule C- Profit or Loss from Business (Sole Proprietor)
- Check to see what tax reporting is required by your state tax board and local municipality
- If you drive for Uber and also sell items on ETSY, a separate Schedule C is required for each source of business income.
Self-Employment tax of 15.30% is required on all Annual Net Earnings of more than $400
- Sole Proprietors & Independent Contractors must pay both the employer and the employee side of Social Security and Medicare taxes; this is called Self-Employment tax
- The 2015 SE tax rate on Net Earnings is 15.3% (12.4% social security tax plus 2.9% Medicare tax).
- The Self-Employment tax rate is 15.3% of the first $118,500 of income and 2.9% of everything above that amount
- If you also work as an employee, be careful that you do not overpay your Social Security tax. The $118,500 applies to your combined wages, tips, and net earnings
- Self-Employment taxes are reported on Federal Form Schedule SE
- Sole Proprietors can deduct ½ of this cost on 1040-Line 27, the deductible part of self-employment tax
Tips for Financial Success:
- Don’t Co-Mingle Personal & Business Money – keep separate accounts
- Maintaining separate accounts helps to show your business intent of making a profit
- Use tax planning for better cash flow management
- Profitability is the goal for most small business and one great tool to get there is to use the tax laws that are designed to help your success
- Fine tune your DIY process and use the above information as a guide – schedule time to review financials and calendar dates for payments
- If you want some help or prefer a “Do it for Me” process, contact me for an introductory special
Your Success matters to me.
My intent is to use my blog to educate and empower others by teaching tax rules to save you money. Thanks for reading!
You either master money, or on some level, money Masters you” – Scot Alan Turner
Deborah Ann Fox, CPA is working to make a difference in peoples lives and wallets, by helping them build and protect their financial health. Her mission is to be an affordable & accessible resource to help answer money questions for individuals and small business. She can help by being your compass while you captain your ship.
Debbie offers free 30 minute no obligation consultations and is available for appointments – including remote. More information is available at http://www.debfoxfinancial.com. Questions or comments can be sent to firstname.lastname@example.org