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Interview with an Enrolled Agent
In this podcast/video/blog I speak with Amy Wall, an enrolled agent, which means she is licensed by the IRS to represent taxpayers and she has a degree in economics. She works on taxes for individuals and business owners at the Tucson Tax Team (http://tucsontaxteam.com/). We discuss business taxes in this blog and podcast and on our video: https://youtu.be/tp4flpAFrRo
The following are some excerpts from our talk.
Difference between Employed and Self-employed
One of the big distinctions between W2 employees and self employed people is that W2 employees have social security and medicare withheld and the employer matches that withholding and sends it to the IRS. Self employed people need to pay both halves of the contribution – an extra 7.5% (FICA taxes or self employment taxes.
There are penalties and interest if taxes due are not paid or if they are late. Self-employment income, many times, varies significantly. It is important to plan.
The goal of quarterly payments is to pay so that you do not owe anything and do not over contribute either. Because income is not stable, what would I do with my small business people is to check in several times during the year to adjust quarterly contribution – so they are not caught by surprise in March.
People can take with their business as much as possible to be in the deductible column – it reduces your income which is an opportunity that people who are W-2 employees really don’t have.
All W-2 employees can take is 2% miscellaneous deductions on their itemized deductions. You can only take the amount that is above 2% of your adjusted gross income so for most people this ends up being nothing.
People who are business owners there’s a lot of things that you can take that reduce that net income reduce the self-employment tax and it’s taken right on the Schedule C.
Office in Home Deduction
If you saw the movie the accountant, the number of home office deductions actually had a substantial jump up after that movie came out. An office in home was considered the single most heavily audited item and people were afraid to put in offices at home even if it was legitimate because they thought it was an automatic red flag. That is much less the case today because a lot of people really are working out of their home.
For office in home as exclusive office use, you add up your receipts and deduct that percentage of your home. You cannot take the deduction if the space is also your kitchen or has some other use. Examples are a spare bedroom where there is a desk, internet setup and it’s actually your office where you are actually doing your work. It need to be physically separated such as a living room that is sectioned off.
If your office in home is 10% of your home area, you would deduct 10% of your mortgage interest, real estate tax or rent, utilities, security system, insurance.
For some people, keeping track of that is too complex so there’s also what’s called a simplified method which is just a flat dollar amount per square foot.
For a first-time person is we’ll calculate it both ways just to be sure and then once we know then we don’t need to calculate each year.
Mileage Tax Deduction
How about mileage? If you don’t have office in home does mileage matter.
The difficult aspects of being self-employed, if you don’t have an office in home, let’s say that you’re renting an office somewhere – than any drive that’s from home to the first job site is your commute.
Mileage audits should be easy to win. On this day I drove from point A to point B for this purpose of X and it was this many miles. MileIQ is one app that a lot of people use and that helps you track. It lets you print out a report, which is nice, because we don’t want to send your phone to the IRS. If you have a lot of mileage, like a real estate agent, the other thing the IRS can ask to see is independent confirmation that you’ve actually put that many miles on your car so you know how you get your tires rotated and they write down what your miles are at various times.
You can say I know I really did put 3000 miles on my care, but they’re looking for independent confirmation. Small business returns (schedule C) is the single most heavily audited form so proceed at your own risk. Keeping track of it all can be difficult.
I’m not going to lose sleep over being auditor for mileage like a significant mileage and it doesn’t have to be going to a client you could be going to just work related and that’s what like $0.54 some mile and then okay.
But I always asked you can you produce a written log. Just that one item you can get a letter saying show me your mileage log.
Other Tax Deductions
Tax planning can be critical. If you have a bad year, income tax rate is low but next year could be awesome so I would rather depreciate the expense and expense out over time then get help today. Tax planning issues are something that they should look at.
For meals, it has to be business-related to write them off. It can’t just be that I was out in town and I had to stop and have lunch. And even then it’s only 50% deductible. If you are taking clients out to a meal you need to write down on the receipt who you went with and why.
Policeman who dry clean their uniform shirt who are W-2 employees and it’s a 2% deduction on schedule A (itemized deductions).
I’ve had this exact same audits running simultaneously producer of clients and one went one way and won’t let the other because the auditor I was working with one was more lenient the other was going to be stricter I’m a hostess at a restaurant I have to look nice I want to deduct my clothes my hair and yes the exceptions are if it’s a special uniform If you had to buy them yourself which I’m willing to bet you didn’t
Keeping Track
I recommend you use a scanner. It is cheap to scan the receipts and throw the receipt away. Record keeping becomes a bigger mess with more sophisticated more profitable businesses – the IRS starts to have higher expectations. Once we get into things like I have employees maybe I’m an S corp or partnership. Now things are different. We have to have a balance sheet really at some point need a bookkeeper. If you are small business okay the first thing everybody wants to do is run out and get QuickBooks. But why go off and do that when you’re good at making money doing you know. With an excel spreadsheet it is fine for most people or even just a written you know this is what I spent during the month and at the end. Instead of trying to learn new software.
When you are at a different level – hire a bookkeeper. Honestly it’s better than someone trying to learn to do QuickBooks themselves. Many business owners are do-it-yourself first people and they want to do their own QuickBooks and when I say something like generate a balance sheet – they can’t. At some point we set someone up with bookkeepers.
Let’s say I buy a truck and 3 years later I think I’m going to get rid of the information about the truck. No, because the truck is still going to be engaged in tax documents. Making up in space inexpensive right now yeah no that’s good how about the different ways to organize your company.
Organization Structure
The most popular thing on the planet right now to be an LLC and most people don’t really know even what that means. An LLC is actually a state create identity. The IRS is confronted with 50 different versions of LLCs they identified what they’re going to do if it’s a one person LLC. If the client is married then by definition it’s going to be taxed as a partnership. An LLC then can also become an S Corp.
Then the way it works is actually really interesting. They are not entities that pay tax on their own so if you file a partnership return, the partnership is not writing a check to the IRS. Same with an S corporation. If you are a partnership and an S corp or LLC is elected S Corp status you are not paying tax what’s happening there called flow-through entity the income and certain areas of certain kinds of expenses flow through to the individual shareholders or partners tax returns so each partner shareholders paying tax at their rate.
If it’s just you or you and your spouse it’s just like a sole proprietorship and you’re paying the full amount of self-employment taxes. Now the reason for S Corp status is they do have to file their own return but the income passes through to the shareholders in two separate streams. Add self-employment taxes going to more than pay for the extra tax return the book keeping the parents that are that are seen all the additional expenses that are involved with running a higher us a higher level business we save thousands of dollars by putting people into.
Most people’s record keeping is so bad, the IRS gets a pretty high return on its investment. Make sure that you can defend your number The IRS has had budget cut backs – so the odds of getting audited is low.