Finance and Taxes
I was happy to discover June Walker's zesty tax column and your well-designed, informative Web magazine. Though June is my real-life tax consultant, I'm glad to find that there's a source for regular doses of her wisdom online. It's comforting to my finances just to see her face on the screen.
Meanwhile, she drew me to look at the magazine, which looks like another thing I have to add to my short list of regularly visited Web sites.
That is, if I know what's good for me.
I love June Walker's column. It's fast, funny, and practical, and she really knows her stuff. This is a wonderful service.
My wife just started her own business, and I volunteered to keep her records and file her taxes. I found June Walker's columns on Finances and Taxes just in time. I had some questions about what qualifies as a business deduction, and her column helped tremendously. I also enjoyed the rest of your Web site -- your articles are very easy to read and understand.
Martin of "Martin & Connie"
I just bought a house and a shop. I'm doing business out of the shop under a business name. Should I pay myself rent for tax purposes? Also, I own a bunch of tools I bought before I started this business. Should I sell these tools to my business? My business is a sole proprietorship.
Our tax columnist June Walker responds:
The IRS doesn't allow you to pay rent to yourself and then deduct the payments as a business expense.
There are a number of ways to get around that. For instance: If you were doing business as a partnership instead of as an IP, then the partnership (a separate entity) could pay rent to you.
Another point: I don't know if you're married or not, if you live in a community property state, or what type of ownership interest you have in the building. All of these factors play a role in this tax situation. Depending upon the type of ownership you have and which state you live in, if your spouse were to own the house and shop, you could pay the rent to your spouse since you wouldn't be the owner of the building.
Keep in mind that renting from your spouse, or receiving rent from your partnership would not reduce your income tax, it would only move income from one part of your tax return to another.
There could be some Social Security tax savings, however. For instance, if you rented from your spouse for $1000 per month you would save about $1500 per year in lower Social Security taxes.
The good news is that, regardless of your marital status or in which state you reside, you can deduct all your shop expenses on your Schedule C, Profit or Loss From Business. Expenses include everything from property taxes, utilities, and roof repairs, to depreciation. If the shop is a separate structure there is no limit on taking the expenses in the year they occur. If the shop is physically part of your home (part of your garage, for instance) and if your business does not have a net profit, you will have to carry forward some of the expenses to future years.
As to your second question: you do not actually have to sell your tools to your business. Here's what to do:
Make a list with four columns.
In the first column write all the tools and equipment that changed from personal use to business use on the day you started your business.
Next column, put the date that you purchased the item.
Next, the purchase price.
Next, write down the fair market value (FMV) of the item on the first day of business use. (Fair Market value is the amount that a willing buyer -- not your rich uncle but a stranger in the same business, for instance -- would pay for an item.)
For your new business you will be allowed to reckon the cost of each tool as the lower amount on the list -- either the original purchase price or the FMV. In most cases the fair market value will be the lower, but if you bought a special tool five years ago that is no longer available, it may be worth more today than at the time you bought it. You have to use the lower amount -- it's an IRS rule.
Where you put the cost of individual items on your Schedule C will depend on what the tool is and how you decide (or your tax advisor decides) to deduct it.
I also suggest taking photos of the tools and equipment, to be kept with your tax files. (Also good for insurance purposes, by the way.)
Good luck in your new venture.
I'm enjoying your "e-zine" very much and find it very relevant to common IP issues.
After reading June Walker's column "You Say You're Self-Employed...?," I still had a question. I am an independent training consultant, and I sell my services directly to client organizations as well as working through agencies.
I control my own time, work mostly from home, and am not told how to do the work. Although I'm hired on a project basis, I generally charge an hourly or daily rate to the client or agency. I have an employer tax ID number and carry my own insurance.
Once in a while an agency will only want to pay me by W-2 wages. I prefer to be paid 1099 wages as an independent contractor because it allows me to contribute a percentage of those wages to a Keogh plan for retirement. The agencies are often unclear as to why they insist on paying W-2 wages, except to say they are fearful of repercussions from an IRS audit.
It appears I meet the IRS criteria for self-employment, so what are the legitimate concerns of the agencies? How can I help to ease their worries so that they will be more open to paying me freelance wages as a 1099?
I appreciate your assistance.
June Walker responds:
Just because the agency is intimidated by Uncle Sam doesn't mean you need to be. Here's what you should do: First, to be sure you're really self-employed, read my column (immediately following the one you already read) about Criteria for Self-Employment. Also, download IRS Publication 15-A and read Section 2. Employee or Independent Contractor. If, after that, you still have doubts about your status, get hold of IRS Revenue Ruling 87-41. (Although it is no longer in print, you can get a copy from the nearest federal depository library.)
After you have this information in tow and are confident that you're self-employed, you should file FORM SS-8 ("Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding") with the IRS. The form is long but easy. You will then receive documentation from the IRS confirming your independent contractor status. You can show the documentation to the apprehensive agency to allay its fears.
After reading June Walker's column "You Say You're Self-Employed...?," I was still left with a question.
I do freelance work for an ad agency in New York from my home in LA. When they pay me, they do so as though I were an employee: they take out withholding, FICA, and even California state tax. Does the IRS therefore say that I'm an "employee," even though I do the work from my home, set my own hours, and I'm not told specifically how to do the job?
It seems the IRS could apply the same rules that cover statutory employees -- allowing people like me to deduct my costs directly on a Schedule C, instead of subjecting them to the 2% AGI.
Is there any movement in that direction, given the numbers of people working as IPs (independent professionals) today?
June Walker responds:
Your familiarity with tax terms like FICA, Schedule C and AGI is uncommon. However, you make the common mistake of asking questions about the type of income you've earned after you've earned it. As I said in You Say You're Self-Employed...?, it's too late now. As far as the IRS is concerned, you are an employee of the New York ad agency. If you believe you really are an independent contractor to this agency, and you earn enough income from this one agency to make the effort worthwhile, then consider getting yourself a tax professional who really understands the IP tax picture and can help you get your status changed.
From now on, remember: if you consider yourself an IP, you must discuss your work status with the individual or firm hiring you prior to doing the work and receiving your pay. In future columns, I'll discuss which factors the IRS looks at in determining "employee" or "independent contractor" status.
By the way, since you live in California and work for agencies in other states, be sure to file any tax returns required by your non-resident income.
You ask about "statutory employees." The IRS has four categories of independent contractors who are considered statutory employees:
The only one of these categories you could possibly fit in would be #3. But based on what you've said, I doubt it.
I really enjoy June's column at 1099. I have a question regarding IPs who are overseas.
I'd like to offer my engineering services to American companies when I move back to Hong Kong at the end of this year. I am both a Hong Kong and U.S. citizen. Should I contract my work through my Hong Kong-based consulting firm, or through a third-party company? What are the tax consequences? How do I report my taxes?
June Walker responds:
Thanks for the kudos. I always think it's cool when someone enjoys tax talk.
Unfortunately, I can't really answer your questions based upon the brief general information you've provided. For example, does "my" mean that you own the Hong Kong company, or is it your client? On what tax basis does the "third-party company" you mentioned hire its staff?
This can serve as a cautionary note for people looking for tax advice: only if you give the right information will you get the right answers. A good tax professional, like a good doctor, will ask you lots of questions.
By the way, some of the factors that may affect your taxes are:
June Walker has been, simply put, a wealth of knowledge, guidance, and support over the last decade. I was referred to her by a fellow IP musician. With her help, I've organized my record-keeping and approached all aspects of my business in an enlightened way. The security of knowing how to conduct business within the framework of today's tax laws is invaluable. June is a jewel in the desert of the self-employed.
Mark T. Dacey
For those who didn't catch the pun, June Walker (our tax columnist) lives in the desert in New Mexico. We're obviously big fans of hers ourselves... but we don't entirely accept your metaphor of IP-hood as a "desert." We know what you mean, but we'd rather think of it as a tough place to live that can also be very rewarding. At the risk of sounding sappy, let's work together on making it less of a desert and more of a garden.
Finally an understanding voice! As an "IP" I need to catch up on articles and information that would help me, but I have not always had the discipline to do so. The majority of my concerns and most of my energy are focused on artistic production. At tax time there is always the added stress of making up for my past lack of effort in keeping the numbers straight. June Walker's column is the clearest assessment I have seen of my situation as a sole proprietor/IP. Thanks June for allowing me to see myself... and thanks for the pronounced tone of respect.
Great article... I liked June Walker's tax article. I look forward to seeing more of her information. I like your site in general. I am a self-employed person and plan to log on regularly.