Click here to order the March 2015 issue in which this article appeared.
Do New IBOs Know What to Do with Their 1099?
When a new independent business owner (IBO) gets recruited to a new opportunity, the “business owner” part of the term IBO doesn’t always sink in at first or with the breadth of what that status means to them. Even if they are aware that they are now a business owner, most do nothing about it until they get their first 1099. By then, the tax year is over and it’s too late to take full advantage of the opportunities available to them.
For some, it’s “old hat” and they know what and how to track for tax purposes. But for most, who are used to receiving a W-2 from an employer, getting involved in their own business is as unfamiliar as going to a foreign country where everyone is speaking a different language. It’s fun and exciting at first because it’s new and different. But soon—very soon for some—they get frustrated in this “foreign” environment and quit before they see any benefit from it.
Receiving a 1099 from a company is very different than receiving a W-2. We all know how employers withhold FICA, Medicare, Social Security, federal income tax and (if applicable) state income tax. A net paycheck is called “take home pay” because the employer takes out all of the taxes and remits them to the respective government entities on behalf of the employee. However, a 1099 is different. It’s for the full amount received, and many don’t realize the multiple levels of taxes owed, including self-employment tax and income tax. They can no longer rely on the fact that the “employer” took care of the taxes on their behalf; they are forced to take matters into their own hands, or pay more than they should in taxes.
The good news is that if they are presented with the right training up front, from a positive and proactive perspective, new IBOs can be shown that business ownership has advantages in the form of special tax treatment. The amount of the 1099 income becomes the top line revenue on a Schedule C (filed as part of the Form 1040) from which deductions can be taken. If the net result from a profit-motivated endeavor is a loss to the IBO, that loss can offset other income on their return, including W-2 income and it can reduce their overall tax bill. This can make their “investment” into this new venture a little easier to swallow, until they start making more money.
When success comes and they have a net profit in their business, their tax perspective changes from the tax benefit of the losses to the tax savings from every deduction. Depending on their tax circumstances, most IBOs will save anywhere from 25 cents to 50 cents or more for every dollar of deduction on their Schedule C. Either way, losses or profits, tracking tax deductions should be one of the highest priorities for all IBOs.
The following are some of the typical concepts or deductions IBOs should be aware of:
Determining the business start date is important because of the timing of expenses incurred. Technically, any business-related expenses paid before the official start of the business are considered “startup expenses” and are treated differently. Even though the net effect of these “expenses” will be treated the same as if they happened after the official start date in most cases, having them separated out and having an official “start date” is a good idea and will arm a tax preparer with the correct information.
For tax purposes, a specific vehicle should be established as a “business use” vehicle. At the very least, on the day the business starts the IBO should record the odometer reading of the vehicle and then keep a business mileage log to track each time the vehicle is used for business. Each log entry should have three things: the date, miles driven, and the business purpose.
Business Use of Home (or Home Office)
The IBO may already be using part of their home as an office or work space. Most of the deductions related to the business use of the home are calculated from documents that are sent to the IBO after the end of the tax year, such as year-end mortgage interest statements, including total payments for insurance, as well as real estate taxes. However, planning to take a deduction for the business use of the home requires some forethought.
To take this deduction, the Business-Use portion of the home cannot be for casual and occasional business use. IBOs must use that area of their home regularly and exclusively for business. If they have an office at home, or even a place to store business products, the square footage of that area—in relation to the total square footage of the home—is the percentage used for all the home office deductions. Making sure the use of the area is managed properly is the key to being able to take this deduction.
If IBOs have a cell phone used for business they can deduct a portion of those expenses. Technically, they write off the portion of business use calculated as the portion of minutes used for business calls vs. minutes used for personal calls. (An experienced tax preparer should be able to offer alternative methods of determining the deductible portion of cell phone expenses.)
Meals and Entertainment
This is a special category of expenses that only qualify for 50 percent of the amount spent. IBOs also should keep in mind that these expenses only qualify if they are entertaining someone for business purposes. When treating a prospect, a client or customer, or an employee to lunch, IBOs should record the name of the person treated and a brief description of the business discussion or business purpose.
When treating a business prospect to some form of entertainment just before or after an event in which business was conducted, make sure records document who was involved and the business purpose.
Meals for the IBO while traveling for business are deductible but have the same 50 percent limit.
When traveling overnight for business and there are more travel days than personal days, IBOs can deduct the cost of transportation as well as other costs associated with their travel. A business day is defined as one in which more than four hours of business is conducted. If the IBO has more business days than personal days, the travel costs to get there and back are considered business days. (This is for domestic travel only. Consult a tax professional for the rules that apply to foreign travel.)
There is a reward for taking a proactive approach and helping your IBOs understand and commit to this important part of their business.
Once your IBOs are engaged in the “business practice” of consistently tracking deductible expenses and mileage, and in turn reap the rewards of their newfound consistency by saving hundreds if not thousands of dollars on their tax bill, their entire mindset will experience a shift.
They will move from a perspective of experimentation to one of entrepreneurship. They will see their business as a business rather than a short-term endeavor undertaken to try to earn some extra money.
Your reward is multiplied. You gain a business owner who is more dedicated to your company’s opportunity and more willing to keep going in months two, three, and four, even if profits haven’t yet surpassed expenses because they understand that the monetary gains in tax savings can be greater than the monthly cost of their autoship. And that IBO will now teach the importance of this “business practice” to his or her organization.
This is where true retention begins.
Disclaimer: This information is being shared as examples of what to track and is in no way intended to be a complete or comprehensive list of deductions available to business owners, nor is it intended to be tax advice. It is recommended that IBOs consult their tax professional for further clarification of all tax rules and how each applies to their circumstances before filing a tax return.
William W. Olsen, CPA, CVA, MAFF, is Co-Founder of Deductr, a provider of tax-related software services for businesses. He has been in public accounting for over 20 years.