Friday, February 21, 2014

Tax Implications for Self-Employed Consultants

Picking up a second job to supplement household income in a tough economy is becoming more common. Many Americans are choosing to become consultants that visit homes to sell make-up, jewelry, candles, kitchen utensils and food products. But filing taxes as an independent contractor is a lot more involved than as a traditional, full-time employee.

Conducting business as a sole proprietor is one of the simplest forms of operation. It’s easy to start a business operated as a sole proprietorship and equally easy to discontinue. But with this comes the challenges of proper maintenance of accounting records for tax filing purposes. Here are some of the tips that will help you in the process:
1.   Open a separate bank checking account for this business. This account has to be separate from your personal account. Don’t co-mingle the accounts as you will spend a significant amount of time analyzing the transactions from a tax perspective.
2.     Deposit all business income in this bank account. It could be cash or check. Pay all the business expenses from this account. The payment could be in the form of check, cash withdrawn for paying the expenses or via ATM/Debit card. These days most bank offer Bill Pay facility through their online service. You should avail of this service as usually it is a free service by the bank. You can log in and pay a vendor or an individual and the bank would issue a physical check to that person. You save the time of writing a check and incurring the cost of mailing.
3.        Another valuable tip for independents is to pay estimated taxes to prevent any additional interest charges.  If your business is profitable, you will likely have to pay estimated taxes throughout the year, usually on a quarterly basis.  Also, don’t cheat yourself – anything that is business-related is tax deductible.  Deductions can be taken on everything from home office and utilities, phone and internet charges, office supplies and transportation expenses, be it carfare or mileage.  Once again, it is crucial to provide proof of payment and an explanation of the business nature of the expense.  If you are deducting travel expenses, be sure to have proof of where you went and why.
4.   Home office deductions, which are often the largest deduction, are determined by deducting the square footage of your home office area from the total square footage of your home to calculate what percentage of your mortgage, rent and/or maintenance is deductible.  You may even be able to deduct a portion of your utilities.  On top of all that, “Client meals and entertainment costs are generally 50% deductible,” says Payne.
5.     Taking advantage of the latest health insurance filing change can also be helpful.  Effective this year, health insurance is now 100% deductible against your income to the extent that your business is profitable.  That’s a change from previous years, when it was a standalone deduction unrelated to your income.  “The Benefit of this change is that it lowers your self-employment tax, also known as social security tax,” says John Murrill, another NTA endorsed CPA.
6.     If you have a high-deductible health plan, a sensible choice for independents who rarely tap into their medical coverage (because the monthly premiums are lower) might be a Health Savings Account (HSA).  With a HSA, you contribute money that goes towards paying medical expenses.  The contributions you make to your HSA are tax deductible (up to certain allowable limits), which lowers your taxable income.  In order to qualify for an HSA, your health plan must have a deductible of at least $1,200 for an individual or $2,350 for a family.
7     Another good way to lower your taxes is to open an Individual Retirement Account (IRA) or a Simplified Employee Pension (SEP) plan to secure retirement savings.  These retirement-savings plans are usually for people who don’t have a 401(k) plan available to them.  An IRA allows you to save (and write off) up to $5,000 a year toward your retirement.  If you think you want to sock away more than $5,000 a year towards your retirement, set up a SEP plan, which allows you to contribute approximately 20% of your income.  One stipulation is that your business must be profitable in order to contribute any money to a SEP plan.
8.     If your annual income exceeds $50,000 you may want to consider incorporating.  If you’re an independent contractor, especially in the trucking industry, this is a no-brainer.  If for no other reason than this, you should incorporate your business to protect what you have worked so hard to build.  “Organize your business as a corporation or LLC, put yourself on the payroll, and make an S-Corp. tax election, which could save you $3,000 to $4,000 for every $50.000 in profits,” says Murrill.  If you’re operating as a business such as a corporation or LLC, you must set up a separate bank account.  “Keep your personal and business expenses separate for tax liability reasons,” says Murrill.  Finally, set up a bank account that’s totally separate from your personal account.

Your first step when starting a business is to open a separate business checking account. It will be easier to track your deductible expenses if they are not commingled with your personal expenses. If you incurred expenses prior to opening your business, keep them separate from your other expenses. Special tax treatment applies to startup expenses.

It is important to keep track of your mileage, as you might be eligible to deduct it. If you are self-employed and maintain an eligible office in your home (more on this later) you can deduct the mileage to and from your client’s or customer’s place of business, as well as between jobs. There are two ways to calculate your auto deductions – the standard mileage rate or actual expenses. The standard mileage rate is the easier method as you simply take your total mileage and multiply it by the current rate ($.555 for 2012). The actual expense method is exactly that, recording the actual expenses such as the cost of gas, oil, insurance, repairs, maintenance, tires, washing, licenses and depreciation. This method requires you to keep very detailed records and if you use your car for personal and business purposes, you’ll have to divide the expenses between the personal and business portion.

The IRS allows self-employed taxpayers to claim a deduction for home-based business expenses if they meet certain requirements. They must use the home office regularly and exclusively:
·         As the principal place of business for a trade or business.
·     As a place to meet with customers in the course of the trade or business, or in connection with the taxpayer’s trade or business, if the location is in a separate structure not attached to the dwelling unit.
The IRS may allow a deduction for inventory storage if the product is regularly sold to others and there is no other fixed location available for the business. Home office calculations are divided into direct and indirect expenses. Direct expenses are those that pertain exclusively to the home office, such as painting the walls or installing new carpet. Indirect expenses are those that pertain to the entire residence, such as rent, mortgage interest, taxes, insurance, repairs, utilities and depreciation. Indirect expenses need to be allocated between the business and nonbusiness portions of the home. The amount of expenses you can deduct is subject to specific limitations and ordering provisions. Please contact a tax professional for guidance. 


This article contains general tax information for taxpayers. Each tax situation may be different, so do not rely upon this information as your sole source of authority. Please seek professional advice for all tax situations. Tax professionals are experts who keep current on tax law changes. They can save you time and offer insight on how to use the tax breaks available to you.