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Columns by June Walker: IPs Face Unique Tax Challenges Tax Deductions Are There For The Taking You Say You're Self-Employed -- Will the IRS? Criteria for Self-Employment Do You Have a Business or a Hobby? Proving That You're a Business Keeping Records -- It's Not Just for Taxes Three Ways to Expand Your Business Deductions Can I Deduct Disneyland and Other Questions Mixing Business with Pleasure and Other Gray Areas Quicken for IPs Courses That Qualify Training You Can't Deduct Getting There is Half the Battle Taking Deductions on the Road Getting Credit and Taking Allowances Advertising: Do It, Then Deduct It The Subtle Art of Advertising Deductions Billy Bridesnapper's Start-up Saga Starting Up and Shutting Down Start-Up Wrap-Up Giving Gifts, Taking Deductions

You Say You're Self-Employed -- Will the IRS? "Am I actually self-employed?" Answering this question is the first step towards getting through the maze of tax rules for IPs. Let's start with the official IRS designation. An IP may call herself a freelancer, sole proprietor, independent professional, or sub-contractor, but the IRS calls her an "independent contractor." If you claim to be an IP, the IRS and state taxing authorities have two questions to ask: Are you really self-employed or are you an employee? Is this a business you're running or is it a hobby? You must be able to show that you are both self-employed and engaged in a business in order to qualify as an independent contractor for tax purposes. But before looking at the requirements for being an IP in business, here's a quick review of the difference between pay received by an employee and pay received by an IP, and the tax consequences. A new client of mine said upon our first meeting that he hadn't yet decided how he would treat the income he had earned so far that year -- as IP income or not. Well, sorry, but if the income has already been earned, it's too late: most likely that decision has already been made for you! Often, part-time employees and IPs aren't sure on which basis they're working. There are times when a person gets called to a job, gets paid, and never thinks about whether he's self-employed or not -- until tax-time rolls around and it's important to know. The government changes the definition of income to suit various situations. For the purposes of this discussion, let's stick to earned income -- money or goods that you receive for work that you do (salary, wages, tips, professional fees, etc.). Earned income does not include gifts from Grandma or unemployment compensation or dividends. There are only two types of earned income -- W-2 earnings income and self-employed income. Let's see how to tell them apart. Rick Reporter writes a feature story on sailing that was not assigned by his editor; but the editor likes it anyway and the piece is published in the Sunday color supplement, "Jaunty Journal." Rick is paid $1000 for this feature. In his next paycheck the payment is added to his regular weekly salary. Taxes are withheld. That $1000 is W-2 income. Rick then decides to send the piece to "Mariner's Monthly." The magazine accepts it virtually unchanged and will also pay him $1000. Two months after publication Rick receives a $1000 check from the magazine. No taxes are withheld. That $1000 is self-employed income. Simply -- if taxes are withheld, it's W-2 income. If no taxes are withheld, it's IP income. Rick received the same amount of money for the same piece of work, but generated two different types of earned income, which are treated differently on his tax return. That's why it's important to understand the distinction and why it is important to keep them separate. W-2 income can be called salary, paycheck, wages, take-home pay, or regular income. Those who earn W-2 income are called employees. I call them "W-2 people." At the end of the year W-2 people receive a W-2 form from their employers stating their income and withholdings for the year. The government also receives a copy of the W-2. Self-employed income can be called freelance income or commissions. If an IP is paid $600 or more in one year by an individual or corporation, the IP should, at the end of the year, receive from that individual or corporation a Form 1099 stating "miscellaneous compensation" paid. The government should also receive a copy of the Form 1099 from the payor. Even if the IP receives no 1099 (because it totals less than $600 or because the company neglects to send it) the income is still taxable and must still be claimed on his tax return. Anouk Astrologer's gross income is $20,000 a year as an IP, and her neighbor's total wages are $20,000 as a supermarket employee. Let's take a look at how the same income amounts compare from the perspective of net income for the self-employed and take-home pay for the employee. For W-2 people,gross wages minus deductions = take-home pay. Because of withholdings, Social Security, and other deductions, W-2 people receive take-home pay that is considerably less than their gross wages. Rick Reporter, who made $1000 extra for the piece in his paper's Sunday supplement, did not take home an additional $1000. Deductions probably reduced it to about $600 in take-home pay. To review: A W-2 person's tax is calculated on gross wages. With his take-home pay he buys food, pays rent, goes to the casinos. But he doesn't have to pay taxes with it: his employer has already withheld the tax and sent it on its way to Uncle Sam and the state tax office. When a bank loan officer asks a W-2 person to state his income, the banker is asking about gross wages. For the IP,gross income minus expenses = net income. Rick Reporter received a check for the full amount of $1000 from "Mariner's Monthly." His expenses were $100 for a sailing publication used in his research and a $20 FedEx fee. The $1000 is his gross self-employed income Less $120 in expenses Equals A balance of $880, which is his net self-employed income. To review: An IP's tax is calculated on net income. It's from his net income that he buys food, pays rent, goes to the casinos -- and pays taxes. When a bank loan officer asks an IP to state his income, the banker is asking about net income. Many people think that being paid as an IP proves that they are self-employed. Not so. In upcoming episodes of this column, I'll show you how to ensure that you are considered self-employed and in business. (c) 2000 June Walker. All rights reserved. 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