 Income tax 2022-2023. Are you self-employed? Support Accounting Instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need then can be done on a YouTube page. We also include added resources such as Excel practice problems PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Let's do some wealth preservation with some tax preparation. Most of this information comes from the tax guide for small business for individuals who use Schedule C Publication 334 Tax Year 2022. You can find on the IRS website irs.gov irs.gov. Looking at the income tax formula we're focused online one that being income remember and the first half of the income tax formula is in essence an income statement although a strange one. We also want to note that this is basically a skeleton format that we can easily visualize and a lot of other information would be feeding into it from other forms and schedules. This basically representing the first page of the form 1040 where we have an income statement type format starting with the income section then we have the adjustments to income which you could call above the line deductions similar to expenses if it was an income statement terminology gets us to the subtotal of adjusted gross income agi and important subtotal because when we look at phase outs for example as income levels rise of credits and of deductions they're usually based on this subtotal adjusted gross income agi rather than the income line then we have the greater of the standard deduction or itemized deductions you could think of these similar to expenses again we're going to take the greater of these two you could call these the below the line deductions is tax deductible gets us to the taxable income which is in essence equivalent to net income in a normal type of income statement everything's flipped on its head where we want the taxable income to be as low as possible as opposed to normal income statements in normal situations where we want the net income to be as high as possible that means we would like to be able to exclude income if possible if legally possible up top and we would like to have our deductions which are kind of similar to expenses as high as possible now note we're back up here on the income line when we're thinking about the formula with regards to what's being reflected on page one of the form 1040 however we're going to feed into that now the business income and the business income is going to come from another schedule the typical schedule and the one we're focused on here is for small businesses that being the schedule c now the schedule c is going to be a whole nother income statement and an income statement that is much more what we're used to seeing in terms of an income statement in other words we're going to have a schedule c which will have income from the business expenses from the business the expenses are still in essence deductions but they're kind of normal and natural deductions that we would expect from an income tax system in other words if you have an income tax system you would expect that the deductions would be those things that you needed to consume in order to generate revenue so that you tax people on the net income not on their gross income if you tax people on their gross income then you're going to be favoring some industries versus other industries and the the one industries that need more uh more investment more expenditures in order to generate the revenue are going to be disincentivized right so that's the general idea and that actually makes good sense when we think about the schedule c so it's the net income from the schedule c that flows into the income line on the form 1040 so that's a little bit confusing because this income line then already is including a bunch of expenses when pulling in something from a schedule c type of business because you're pulling in the bottom line of an income statement which was the income minus the expenses the expenses being the business deductions now when you don't have business income the other income on this top line usually comes from like w2 income and the idea with a w2 income is we don't have those other kind of expenses because the employer is thought to be the one that's going to be uh laying out those types of expenditures therefore most of these deductions on the actual form 1040 the adjustments to income and the itemized deductions aren't really like natural expenses to that we would think of for an income tax type of system there are expenses that are trying to change our behavior or incentivize certain things stimulate the economy whatever they're trying to do but actually the schedule c is is more straightforward in that the expenses that are there uh make sense to us from a normal kind of income statement or tax income tax type of system but the net income is going to flow into this formula it's the bottom line so when we're looking at then the first page of the form 1040 we're focused here on other income from schedule one this is where the schedule c is flowing into the first page of the 1040 which we can kind of visualize in this formula format and this number then that's flowing in from the schedule c is the net income which has already been decreased by the business deductions now that came from the schedule c where we had income of 120 minus expenses which you can't see here was 20 000 the net income is what pulled into the first page of the form 1040 on the income section of the form 1040 okay are you self-employed answer you are a self-employed person if you carry on a trade or business as a sole proprietor or an independent contractor usually this is a fairly straightforward situation but there are areas where it can be less straightforward and people often have questions as to whether they're self-employed or not and what the tax consequences would then be let's first take a step back and think about the irs's perspective with regards to your revenue from the irs's perspective anything that we receive should be basically classified as revenue unless the irs code has exempted it from income and remember that reporting it as income is bad for taxes because that means in an income tax system we're going to be paying tax on it now the irs has a perspective to kind of look over everybody's shoulder to try to determine if people are reporting their income or not and if you think about most transactions you have a payer of the transaction and then you have the recipient in the transaction so someone has income and the other one has a deduction from the tax perspective the deduction is good and the income is bad everything's flipped on its head right so in for example an employee employer situation which most of us have been in at some point or another we might have w2 income that we're receiving from the employer the irs actually has leverage on the employer in that situation to give the irs information about the person that they're paying why because the employer wants to get a deduction for the wages that they're paying to the employee the employee has an incentive not to report their income they should report their income but that's where the irs is going to be skeptical that the employee is not going to report their income so they basically force the payer and that situation the employer to give the w2 not only to the employee but also to the government so that the government knows how much the employee paid earned and they force the employer to be the government's tax collector taking the money out of the paycheck before the employee even receives it so you can see how the so the situation is going to work there now if you are self-employed type of situation the government doesn't have the same kind of leverage in an employee employer situation although they still could have some leverage because if you're a sole proprietor that's working for another business instead of individuals then that business still wants to take a business deduction although you're not an employee you you still are getting paid and so the irs can say hey look if you want that expense to the person that's paying you as a sole proprietor we want you to tell us the money that you're paying not with a w2 we won't force you to take the withholdings but with a form 1099 so if you're a sole proprietor then you might get these 1099 forms which would indicate that you would have to report as income but remember the fact that we got a w2 form or a 1099 form does not necessarily mean that we would have to record income or not record income those are just going to be informational forms the iris is kind of trying to look over our shoulders and oftentimes because of those informational forms because of the intrusive nature of the irs trying to get more and more information about people's revenue we start to think that we don't have to record income unless we get a form like a 1099 or a w2 and that's the kind of what I'm trying to drive out here that shouldn't be the thing that tells us whether or not we have to report income or not that's the thing that the iris is using to double check that we report income so for example if you're in a type of business where you're not working for another business you're working for the end consumer an individual like someone that that is a hair salon or a massage parlor or a restaurant now you're dealing with people that don't have business expenses so they're not going to issue you a 1099 because the irs is not pressuring the individual the iris has no leverage over someone getting their haircut to to have them give the person who cut their hair a 1099 form because I don't get a deduction for getting my haircut right does that mean that the person that got the money doesn't have to record income no no it doesn't you still have a sole proprietorship and you still should be reporting the income for tax purposes but it does mean that you're less likely to have that that informational form telling you such as a w2 form or a 1099 form telling you that you have to record income so I think that's where a lot of people get confused when they go from a w2 situation to a sole proprietor situation you can also imagine situations where people go from a w2 situation to also picking up gig work so now they're doing gig work on the side and they might think this is just a side thing it's not actually my job I still have a w2 job but obviously from the irs perspective they're going to want some of that gig money as well they see that as a business and they're going to want you know some of that money and you can understand that the other thing that gets kind of fuzzy sometimes is when you have a a hobby so a classic case was was when they had horse racing people like to buy horses right and have them have horse racing but it was pretty clear that they were losing money all the time on these horse races and it was more of a hobby it was a very expensive hobby but they were losing money so if they reported a schedule c business they would actually have losses and the iris wants a piece of your earnings they don't want a piece of your losses they want you to make money and then the iris takes some of it they don't want to take on the risk of a loss and then and then compensate you for the losses so if you have a business with a loss the iris is going to be skeptical that it's not a business but a hobby and so therefore they're actually may restrict you from recording it as business income but rather hobby income so that they possibly can still get a bit of the income without without you reporting a loss now if you do have a loss and it's a legitimate business don't be afraid of reporting a loss if it's a legitimate business loss we'll get into that later but the hobby versus a business is another area where people often get confused also just note that the iris tries to make a delineated line between someone being an employee and someone being a contractor or a non-employee situation so that's another gray area that can happen now there's not always a a set line you can try to come up with some with ideas of when someone is an employee versus when they're a contractor but you may have some situations where you can decide whether to be an employee or a contractor because you're kind of you're not you're not in one category or the other specifically and you might be in a situation where you want to ask yourself do i want to be a sole proprietor or do i want to be a w2 employee and situate yourself in one of those two areas there's pros and cons to either one when you're hiring other people you have the same question do i want to hire them as an employee do i want to hire them as a contractor do i want to take someone on as an equity partner kind of situation so we'll dive into some of those more questions in future presentations but caution you do not have to carry on a regular full-time business activities to be self-employed in other words you can have a side job you could just be doing some gig work and yes the iris wants their share of your money whether you get a 1099 or not having a part-time business in addition to your regular job or business maybe self-employment so trade or business a trader business is generally an activity carried on to make a profit so this often comes up with that fuzzy question of is it a hobby versus is it a business if you're in business to make a profit then it's generally going to be a business if you're if you get a little bit of money from a hobby but you have way more expenses than income you can see what the iris is going to do they're going to say i don't want you to record it as a business because you're going to have a loss and you're going to write the loss off against other income no we want you to record that as a hobby so that any income you get we want a piece of it but we don't want to take on your losses right that would be a so the the facts and circumstances of each case determine whether or not an activity is a trade or business so you do not need to actually make a profit or be in a trade or business as long as you have a profit motive so that's the other side of the coin remember that if you are in business for profit it's likely that you do have a loss maybe for the first couple of years that's what often happens for small businesses and and a lot of small businesses go under that's just the way it works because that's that's entrepreneurship that's risk taking and whatnot so the fact that you have a loss if you have a profit goal don't be afraid of reporting a loss but if it's a hobby then it's not a for-profit business okay so you so you do need to make ongoing efforts to further the interests of your business so if the IRS was to audit you or something like that you'd have to prove to them hey look yeah I was in it for business here I messed I may not don't be embarrassed that you did it failed a lot of businesses fail and that's fine but I wrote it off legitimately here because I was trying to make money on it so an LLC is an entity formed under state law by filing articles of organization now whenever we have a sole proprietorship business you've got different kinds of structural entities that then can come up which could be supportive or helpful for multiple reasons including possibly liability protection for example it used to be that you had the corporation which was a separate legal entity and then they came up with all these kind of flow-through entities like a limited liability company which if it was a single member then it could be still treated as a Schedule C in some cases possibly and then like a partnership and a S corporation and whatnot so generally the income tax purpose is a so here we have a single member LLC is disregarded as an entity separate from its owner and reports its income and deductions on its own federal income tax return so you got to be kind of careful with those those limited liability companies because the the laws may be different from state to state and and if you're a single member LLC you're trying to get that liability protection oftentimes but then there's questions as to whether how how how much liability protection you're getting from a single member LLC but you might still be able to report it as a on a Schedule C for for which will make it easy for tax reporting purposes in essence so for example if a single member LLC is not engaged in forming and the owner of an entity they may use Schedule C okay so we have a sole proprietor a sole proprietor is someone who owns an unincorporated business by themselves so in other words if it was incorporated then it would be a corporation it would be a separate legal entity now there's different kinds of corporations you could have a sole proprietor i mean i'm sorry you can have a C corporation versus an S corporation but the idea is that it would be like a separate legal entity now if you had one person that just started doing business you started up a hot dog stand or something like that obviously you didn't incorporate it you didn't do the paperwork to make it a separate legal entity you started making money and the IRS wants a piece of your hot dog stand that's all it takes from the IRS perspective you can get into other things you could say well don't i need a business license don't i need this and that yeah you probably do do i need to get a check to make sure i don't have moldy hot dogs in my state or something like that because i'm selling food or something yeah you got to deal with all those codes as well but from the income tax perspective even if you were selling drugs or something that which is illegal the iris still wants their piece if you were to sell the drugs right you get they would still so all from the federal tax perspective and if you just start doing business then you're going to be a sole proprietor now the tricky thing is that if a partnership just started doing business then they would technically be a partnership right so if two people start of the hot dog stand it's a partnership the problem with a partnership is that it becomes more difficult to kind of determine who gets allocated the income normally you would have a separate return a partnership income tax return that would then flow into the individual tax returns so be careful if you're a sole proprietorship and you want to grow do you want to take on partners or do you want to hire contractors or employees if you take on partners then you do lose some of your control over the business and the partner's decisions are our decisions that you could be held liable for so so possibly in a partnership work so any case you are also a sole proprietor for income tax purpose if you are an individual and the sole member of a domestic LLC unless you elect to have the LLC treated as a corporation so another like single member LLC situation independent contractor people such as doctors dentists veterinarians lawyers accountants contractors subcontractors public stenographers and auctioneers who are in an independent trade business or profession in which they offer their services to the general public are generally independent contractors however whether they are independent contractors or employees depends on the facts of each case so in other words if you're in one of these areas oftentimes you might think of yourself you might be able to situate yourself as an independent contractor or an employee and the line between those two is not as clear obviously if you have to be somewhere from nine to five and someone's telling you exactly what to do from nine to five then you're basically going to be an employee the iris will try to if the iris came in an audit you they would say you're an employee and the iris typically wants people in an employee employer situation because remember they have the leverage over the employer forcing the employer not only to report the income they're given to the employee but make them their tax collector so so that doesn't mean so so that's kind of you would think that the iris is angling in that direction so if they were to to try to audit someone as to whether they're a contractor or an employee the iris is going for forcing someone to be an employee most of the time right because the iris has more control in that format but the rules aren't always that clear cut so you might if you use your own tools your own computer you have your own hours you work from another location and so on and so forth you might be a contractor so also realize that when you talk to the iris they're going to frame it as though being an employee is better than being a contractor and it's not necessarily cut and dry like that because it could there are benefits you might get benefits as an employee and it might be more stable and you have a tax benefit and that you're not paying the employer side of a payroll tax basically the self-employment tax when you're a sole proprietor then you have your own business you got to play self-employment tax which is the equivalent of of social security and medicare but you have to pay the employer and employee portion however you also get to deduct your expenses so which could be huge could bring down your net income a lot and of course now you're not you're not subject to the whims of your employer you can do more whatever you want so there's pros and cons to the two situations but remember that the iris as we'll probably we'll see going through this will kind of tend toward they're the good guy by forcing the you into a situation where you're an employee employer situation that's not a bad situation necessarily but it's one where the iris feels more comfortable because they have more control so the general rule is that an individual is an independent contractor if the person paying for the work has the right to control or to direct only the result of the work and not how it will be done so that's the general rule to determine if you're a contractor or an employee once you've determined which you are you want to make sure that you can can prove that to the to the government that you are a contractor versus an employee if that's the situation you're in so the earnings of a person who is working as an independent contractor are subject to self-employment tax for more information on determining whether you are an employee or independent contractor you can see publication 15 a employer supplemental tax guide so are you a statutory employee a statutory employee has a check mark in box 13 of their form w2 wage and tax statement statutory employees use schedule c to report their wages and expenses so now you're in a weird kind of situation there which is somewhat more unusual situation where you're kind of a w2 employee so you're getting kind of benefits as an employee but you also have the situation where you can use the schedule c to report report their wages and expenses so you might be able to get expenses in that case as well even though most w2 employees don't get to deduct you know their expenses because the idea would be that the employer is taking care of the expenses whereas if you're a contractor that's one of the benefits to being a contractor you get to deduct your expenses