 Income tax 2023-2024, business income or loss and other gains or losses, tax software example, get ready and some coffee because we need to know a lot of information to do income tax preparation 2023-2024. First, a word from our sponsor. Yeah, actually we're sponsoring ourselves on this one because apparently the merchandisers they don't want to be seen with us, but that's okay whatever because our merchandise is better than their stupid stuff anyways. Like our trust me, I'm an accountant product line. Yeah, it's paramount that you let people know that you're an accountant because apparently we're among the only ones equipped with the number crunching skills to answer society's current deep complex and nuanced questions. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. Here we are in our Form 1040 example problem using LASERT tax software. You don't need tax software to follow along, but if you have access to tax software, it's a great tool to run scenarios with. You can also get access to the forms, schedules, instructions at the IRS website, irs.gov, irs.gov. Starting with our normal starting point, taxpayer Adam Taxman just trying to avoid a dang Taxman living in Beverly Hills 90210 single file order start off with no dependence. We have W2 income to start with and then the standard deduction at that standard 13.850 to get to the taxable income 86.150 mirroring that in our income tax formula in Excel 100,000 income 13.850 taxable income 86.150. The tax being calculated by LASERT software 14266 that we see here on page two. There's the 14266. All right back to page one. We now want to consider someone who has double who has a schedule C type of business and we'll talk more about a sole proprietor type of business later. For now, we just want to touch on the income part that flows through to the form 1040 and also touching on much of the complications that happen when we are going to add a business entity, even a fairly basic schedule C. So remember when your tax preparer, some of your questions might be or some of your objectives might be some of your plans in terms of your business might be what kind of returns do I want to be dealing with? More basic returns, more complex returns, higher income tax returns for higher income individuals or lower income individuals and do I want to focus in on business returns or not? If I do focus on business returns, what kind of business returns do I want to focus on? Schedule C type of businesses where you have sole proprietors and or possibly other entities like partnerships like S corporations, LLCs and possibly C corporations. Or do I want to partner up with somebody else that's doing those other entities possibly and helping you out with the bookkeeping? And then you do just basically the data input into the form 1040. So that kind of specialization will be important and you will have to turn away clients if they're not within your wheelhouse so that you can maintain the business model that you put together. Okay, that said, let's go back on over and let's imagine that the income is going from this W2 income. Let's remove it entirely. And let's say that 100,000 is coming from a schedule C. So the schedule C is over here. I'm not going to put all the data input for the schedule C. I just want to look at the general idea of income coming through at this point. The basic concept would be that you need an income statement. That means you're going to have to have some bookkeeping element. Most clients are not great at bookkeeping. Oftentimes, if they're a small business schedule C and might need help with that. And even if they are good with it, you still often have things that you got to help out with that are going to take adjustments, meaning the auto expense, for example, because you might have a mileage method you have to deal with. And then you'll have the possibly depreciation that you'll have to deal with. You might have home office situations that you have to deal with, which mean that you're never going to get something if those things are in play that's perfect from the client and will have to do some adjustments in bookkeeping for it. So again, are you the one that wants to take on those bookkeeping jobs or possibly have someone else that kind of helps you with the accounting part of it and then do the data input into the system? So we're just going to put like 120,000 for income just to give our idea. And then let's just put in advertising, let's put 20,000. So that means we have net income, which is going to net out to 100,000. Let's check that out on my form schedule C. So now the schedule C is populated. You can see that this isn't full financial statement. This is basically an income statement, meaning you've got your income minus your expenses. You don't have assets, liabilities and equity. If you have other types of business entities, partnership, C Corporation, S Corporation, you might need the full bookkeeping balance sheet and income statement in some cases. Note that even though this is only the income statement here, you probably want, you would be best to have your clients doing full bookkeeping, using some kind of accounting software like a QuickBooks or something, because that's going to be a huge internal control just on the bookkeeping side, which will help give us an accurate income statement, hopefully to start off with. Any case, we've got the 120,000 of income, the advertising, there's your expense. Now note that this income we may or may not get documentation for it. We might get, for example, 1099s if this business did work for another business, like if we did business for Tesla or something and we happen to make something that they're putting in their production process. Well, then Tesla will have to 1099 us if they want to get the deduction because the IRS will pressure them to do that. But if we got income, like I say, like a masseuse or a restaurant or a hair salon, then the end customer is not going to be able to deduct the services that we are providing and we might not get any 1099s. That means that whatever 1099s we get, we're going to have to report in income at least that amount or more because if we report less than what is 1099, the IRS will most likely automatically basically say, hey look, we got 1099s higher than the income that you reported. Note that if you don't report your taxes and you got 1099 income that adds up to say 120,000, the IRS would then come after you, you would think, for income of 120,000, which isn't actually good because if you did your bookkeeping, you would have had a bunch of expenses, in this case 20,000. So realize that a lot of people get in tax trouble because of that. They ignore the taxes, they get hit with 1099 income and then the tax collectors come in after them for gross income as opposed to net income and when years pass, it's hard to create your books and it becomes a problem, definitely a problem. But in this case, we've got the 100,000. Now that 100,000, where's that going to go? Well, now it's going to go into the Schedule 1. So here's the 100,000 flowing in from the Schedule C and then it goes from the Schedule 1 to the Form 1040. So if you have your bookkeeping pretty straight, that part of it is pretty straightforward. However, we're not yet done there because we also have self-employment tax. Now remember when we saw the W-2 income that if I went back into my data input and go into my income up top and go to W-2, when I had my W-2, if I put 100,000 here, self-employment is being calculated automatically and would typically already have been paid because my employer took it out of our check for us. Note that the amount that we pay as an employee is usually like 6.2%, meaning we only pay half of it because the employer pays the other half. So 100,000, 6,200 was paid for Social Security, 1,450 paid for the Medicare. So I'm going to delete this again. So normally that doesn't actually have an impact if it was a W-2 employee on the taxes because it was already paid. It's just reported on the W-2. But if you're a sole proprietorship, no one is taking the payroll taxes. Therefore, you're also going to have this Schedule SE typically for self-employment tax that needs to be calculated, which is basically taking your net income. We'll talk more about this later when we talk about the Schedule C, but just to get an idea of the complexity that's added on here because of a whole other taxes that we have to kind of calculate now. Notice that it's basically taking both the employer portion and the employee portion, not exactly, but close. So that's coming out to 14,129 when we talk about Social Security Medicare for both the employer and the employee. How to think about that? Basically, it's kind of like you are your own employee for the Schedule C, and the IRS is treating it as though you paid yourself 100,000 of kind of wages because that's your net income that's going to be taxed, kind of like if it was W-2 income, and then they're charging you Social Security and Medicare, but they're not charging you just the employee portion but the employee and employer portion on this amount in essence. It's not exactly like that, but it's pretty close. We'll talk about it more later. But that's significant because that has an impact on whether you decide to be an employee somewhere or not. In other words, sometimes people have a decision. They can say, do I want to be an employee of the particular organization or possibly I can be a contractor. Now, oftentimes you don't have that decision because the IRS tries to make it like black and white, whether you qualify as an employee or a contractor. But sometimes it's not black or white. Sometimes it could be a gray area as to whether someone wants to have their own business or work as a W-2 employee. So the benefit of being on your own is that you can take these expenses for deductions as well as you have freedom and all that kind of stuff. But part of the problem is that they hit you with both the employee and employer portion for Social Security and Medicare. So that's something to consider in the factoring of it. And remember, the IRS is going to argue that you would be better off as an employee. Why? Because the IRS wants more people to be subject to required or mandatory reporting by the employer. They would like everybody to be lined up and have someone be their tax collector, which are the large corporations, the businesses that are basically doing their job for them by collecting the taxes, issuing the payments, and doing the W-2s. So the systems kind of set up, you would think, so that people can try to get people more on an employee or situation. Okay, so that pulls in then here on page two. So now we have the tax calculated, but now I'm looking at this other taxes. So this is the self-employment tax, which of course, as you can see, is significant. Now, the total tax is a lot different here. It's lower, but you can see that now we have the self-employment tax. So the total tax for that $100,000 instead of what we had before, I believe, was $14,266. When I add self-employment, it's at $23,357. So that's a significant difference between the $100,000 that came through as W-2 income and the $100,000 that's coming through as Schedule C income. So if you were an employee, you would have already paid the Social Security Medicare, but only the employee portion, and then if you were a W-2 employee, and then here you have to calculate, again, both the employee and the employer portion as you do this. So it's kind of a little difficult to compare a W-2 situation versus a Schedule C situation, and I would say if this $100,000 was up here, when we looked at it on the W-2 data input, you would have already paid your taxes for Social Security and Medicare, and we would only be calculating taxes for the federal income taxes. Okay, we'll get into more of that later, but also note that we have this number here, which is an adjustments to income. Where is that coming from? That wasn't there before. So if I go to Schedule 1, we can see that on Schedule 1 page 2, we have on Line 15 deductible part of self-employment tax. Now, if you have the self-employment tax, why would it be deductible, like what is going on there? So what ends up happening? Once again, we went from the Schedule C, we took the $100,000, we went to the self-employment calculation and took the Social Security and Medicare and calculated that we're going to pay $14,129 of taxes, but half of that, we get to deduct. This is what pulled into the Schedule 1 part 2 as and above the Line deduction. Now, why would that happen? It's basically because they're trying to mirror what would happen in an employee-employer situation. If you were both the employee and the employer, then you would have to pay, in essence, the $14,129 of taxes. But if you were an employee and employee earner, like a C corporation, you would actually get to deduct the employer portion of the taxes as an expense. And so you would, you need to mirror that on this side as well. And you say, okay, well, that makes sense. Well, why don't I deduct that $7,065 on the Schedule C? It's like, well, you can't deduct it on the Schedule C because that will reduce the net income. And the net income is what we use to calculate the tax in the first place, which results in a circle reference. So you have to deduct it somewhere else. And that somewhere else is on Schedule 1, page 2, because that's an above-the-line deduction rather than an itemized deduction. And so you get that deduction. So that flows through. That's what's flowing through over here. And so now we have this adjusted gross income is impacted. And then we have the standard deduction. And then we also have this qualified business income deduction form. And this is coming from $8995. I'm not going to get into this in detail. But this was when they made and tried to simplify the code a few years ago. This was kind of a plug factor that they had to kind of put in play, which is pretty kind of messy. I kind of like a lot of the changes that they made before the simplified the forms a lot. But this thing can be straightforward in some cases, but can also get quite complex. And you can see it's quite significant. So again, we might talk about that more later. But just to note, that's going to of course add complexity as well. And then you get to your taxable income. So a lot of factors are going on here. And even if you get all that correct, note that you're usually going to also have questions for tax planning. Meaning you're going to have to calculate the estimated tax payments because typically they're going to have to pay during the year. So you have to determine how much they're going to owe next year so they can pay as the year goes. So they don't get hit with penalties and interest. So we have that that we have to consider when they when also if they have depreciable property. We talked about a little bit in the prior presentation. Depreciable property would be like, like long term equipment. You can't usually just expense that kind of stuff, but rather have to put it on the books as an asset. And that means you have to track depreciation schedules. Again, we'll talk more about that later when we get into like the schedule C. But some businesses might not have depreciation schedules, might not have inventory, for example, as well. Another thing that complicates the calculation. So if it's a small business, that's another thing you might think about and say, I will all take on a very easy business like gig work or something like that. But maybe you don't want to take on like a large business that has a lot of equipment or stuff like that because you don't want to do the bookkeeping for that more complex situation. So just some things to consider on the tax on the tax preparation side. So if I tried to mirror this in our Excel worksheet, let's just see what the complications looks like over here if I tried to build this out. So basically we have another income schedule. So you might make a whole nother schedule here. I might make a whole nother schedule and say, this is going to be schedule C, let's call it. I'll populate the whole thing, right-click, format the cells. I'm going to make it currency, negative numbers, bracketed, red, no dollar sign, no decimals. I'm going to put make it all bold, font group bold. And then I'll call this my income statement. So this is a business income statement. And I'll just put the income statement here. So I'm going to say income is going to be the top line item. And let's just say that we have a few lines that I could put income for. Usually there's not many income lines. And let's make this like a header. I'll make it black and white. And then this will be total income. I'll put that on the outside equals the sum, which we said was at 120,000. And then I'll put expenses, expenses. I'll make this black, white. And then I think let's make like part of this will make our blue and border. I know I'm doing this quickly, but I'm just going to give a little income statement. Advertising, 20,000 we said. So total expenses. These are basically business deductions. And we'll sum those up equals the sum of those. And that gives us our net income, which is going to be equal to the total income or revenue minus the expenses. So there's where the 100,000 is coming from. Now, I'll probably do another. I'm going to delete these two cells. I'll probably do another worksheet when we get into the schedule C because you can make a more detailed worksheet like than this. But for now, we'll just say, okay, that's our basic income statement. And then I'm going to pull that into my first line of our formula, which is currently including income from here. So I'm going to say no more W2 income. That's gone. And then if I go back on over double click on the income line item, it's pulling in income from here from here. I'm going to say plus and now add my income from my schedule C bottom line. So there's the 100,000. So okay, so let's say that makes sense. And then I have other taxes because now I have other taxes is the self employment tax. So if I go back on over to other taxes, do I have an other taxes yet other credits? I don't have I have other credits. Let's go here and say to add another one. And I'm going to call it other taxes to other taxes. And I'll do the same thing, selecting the whole sheet, right click. I'm going to format the cells, make it currency, negative numbers bracketed, no dollar sign, no decimals and home tab font group bold. I'll make it large. And then I'm going to say this is going to be self employment tax. I'll make this black and white. So let's make it black, white. And then and then I could do an estimate of the calculation, but I'm not going to do that right now. I'm just going to say first for schedule C. And let's say let's say income schedule C income. I'm going to say this equals this 100,000. And so the tax, I'll let that pull in on itself. And I'll say this is going to be. Well, let's just keep that and then I'll make this one, the blue one. So then the tax, I'm going to let the software do the calculation, which is self employment tax here is at 14129. So I'm going to say this is going to 14129. And then I can look at the rate and see if that looks correct. It's going to be this divided by this is home tab number percent, adding some decimals. Does that look correct? Well, normally you have like social security for employee or for the employee. Let's say social security for the employee or Medicare for the employee. Medicare for the employee or and the tax rates are usually going to be 6.062.062.0145.0145. This is what would happen if you were an employee. Home tab numbers percentifier. So then if I sum this up, you would think the tax rate would be home tab font group percentify around 13.3. If the IRS is treating us as both the employer and employee. So you can see it's not exactly right. It's like like that, but it's pretty close. So we won't go into more detail on the calculation. But yeah, you could see it's just it's significant. So if you were a W2 employee, then of course you would just be paying this and this right on 100,000. If you were a W2 employee, now you're paying all of it because you're an employee. You're paying both employee and employer portion. Okay, let's go back to the first page and say other taxes. I'm going to say this is equal to other taxes that number. So there is that. And then we also have this above the line deduction, which was an adjustment to income. Do I have any adjustments to income yet? I don't think so. So let's put that here after the schedule C. I'm going to say another one. Double click AG just to income. Do the same thing here again and select the whole sheet. Right click format the cells. Currency negative numbers bracketed no dollar sign, no decimals. Home tab font group border. And I'm going to say that this is going to be a half or deductible self employment. Tax debt. And so let's just take that. And then I'm going to say this will be equal to. I'm just going to say this is equal to the other taxes that divided by two. And so I'll let that calculate on its own basically. And so that's going to be this will just be total. This will be total ADJ to income. I'm just going to sum that up. And that's all we have thus far. Let's do a spell check because I'm sure I haven't spilled everything correctly deductible. Okay. And then that's going to go into our formula. So we'll say all right, that's going to be adjustments to income equals this number. Boom. Okay. So now we've got the 100,000 minus the 7069 gets us to the 92936. So that's here. 92936. It's like, okay. And then we have the 13850. That's still good. That would give us to the 7986. But now we've got this qualified business income deduction that's messing everything up. So let's go back on over here and say that I can say that we're going to add another line. Insert. Insert. I'm going to underline this and say this is going to be qualified. We're going to say it's a qualified business income deduction. Qualified, qualified business income deduction. All right. And then let's move this to this side. Check the spelling. Business. All right. And then I'm going to make this blue. I'm just going to let the software do the calculation for now. We might look at it more later. And the software says it's going to be 15817. So 15817. And so then if I calculate my taxable income, this minus this minus that now gets us to the 63269. I know I'm doing this quick, but I went 63269. So there's that. And then page two, tax being calculated by the software, 9228. I'm going to plug that in here and say, OK, tax calculated at 9228. Oh, hold on. That's not the right. It's down here. 9228. OK. So there's the 9228. There's the other tax, 14129. 14129 gives us the total tax of 23357. 23357. So hopefully I know I did that quickly. I'm not going to, I don't want to get into too much detail. Double checking it now because we will talk about it more when we get to the schedule C. But just to point out, just to note all the different impacts that really a fairly basic schedule C is having on the return in each one of those. We can kind of drill down on more detail and every component we talked about usually is going to have more complexity. Like the schedule C, the bookkeeping is going to be a little bit more difficult. We might have a lot of times a home office, which we're almost always going to have to do something with as well as the auto expenses. No matter how good the bookkeeping is, we'll probably have to make adjustments for that for a bookkeeping side of things and a tax side of things. And then again, this deduction is huge and could have its own basic complexities that we'd have to basically, we want to make sure we're in compliance and calculating that properly as well. We have the estimated tax payments that come into play. You also could have retirement plans that come into play and possibility of deductibility of health insurance and things like that. So it really adds a lot of complexity to the tax return even for a fairly basic schedule C business. So we want to just keep that in mind. Again, when we're coming up with our business plan, our business strategy and again be able to tell people this is what I do. This is what I do not do and say, well, you can't even do a schedule C business if that's not my business model. That's not what I'm going to be doing. Okay, if you don't fit my business model, then I'm going to, you know, I set this up the way I set it up for a reason for crying. Anyway, that's how it is.