 Income tax 2021-2022, are you self-employed? Get ready to get refunds to the max, dive into income tax 2021-2022. Most of this information can be found in publication 334, tax guide for small businesses on the IRS website at irs.gov, irs.gov. Income tax formula, we're back up to the income line but that's a little bit deceiving because we're gonna be attaching a Schedule C, the Schedule C being an income statement, having income and expenses, expenses in essence being deductions, the net of that income statement, the net income in essence of the Schedule C, business income statement, going then to the income line in our income tax formula. If we look at the first page of the tax return, we're focused here on the other income from Schedule 1, the Schedule C flowing into the Schedule 1, which flows into the first page here of the Form 1040. Here is the Schedule C, so the Schedule C in essence being an income statement, income and expenses, the bottom line then flowing into the first page of the 1040, although as we saw, there's many other things that we have to take into consideration as well, including self-employment tax and the part of the self-employment tax that is deductible and then the other kind of deductions that would be business related. First question, are you self-employed? And we might further ask a question, would it be beneficial? Would I want to be self-employed or not? If I had a choice. And we can imagine different types of scenarios and situations where there's kind of some crossover or gray area as to whether you are self-employed or whether we are an employee. If we have the capacity to choose between the two, which would be the better choice? And of course the answer is gonna be, well, it depends. If you look at the self-employed individual, you get the benefit of being able to deduct more things. That's what the Schedule C has, you got the income and then all the expenses, in essence being deductions. If you're a W2 employee, you don't typically get to deduct all those kind of things because the thought process would be that as an employee, the employer is providing all the things you need in order to do the job. If you're self-employed, then you're providing those things and therefore you get the deductions on the self-employed side of things. So typically first glance, she'd say, well, self-employed is way better because I want to deduct all this other stuff. However, that's not necessarily the case because as we saw, we also have to think about the self-employment tax that's gonna be involved as well. Self-employment kind of mirroring the payroll taxes. If you're on the employee side of things or the employer side of things, that's gonna be the social security and the Medicare. And that could be quite significant. So if you have income on the Schedule C side of things, you gotta realize that you're paying self-employment tax and you're paying it on basically kind of like the net income of the Schedule C and you're gonna be paying both the employer and employee portion of it. Whereas if you were an employee, you'd only be paying it on the wages that you get and you would only be paying the employee portion of it. So that could be a significant difference. So the bottom line is that if you have a whole lot of deductions, then you would probably rather be a Schedule C type of business even though you're gonna be paying self-employment tax, employer and employee portion in essence of the payroll taxes. And if you don't have a lot of deductions, your business is pretty much straightforward and you get revenue but not a lot of deductions, then you would probably wanna be a W2 if you had the choice because then you're gonna be paying less in terms of the payroll taxes, which is the self-employment and Medicare, you're only gonna be paying the employee portion. Okay, we can also imagine gray areas in the situation. Usually it's pretty straightforward if you're your own business, I've got my own business, I'm getting my own clients and whatnot and that's pretty much a straightforward scenario. But again, you can imagine scenarios where it is a gray area and you wanna think about it both from the standpoint of as you as an employer and you as an employee because even if you're sole proprietorship, if you're hiring somebody else, then you could end up with the same question. Is that other person a contractor or are they an employee? In that situation, again, you got this kind of trade-offs which one would be better or worse. Oftentimes you'd almost rather have them as a contractor because then you don't have as many obligations to withhold their taxes and do the payroll tax calculation and deal with the quarterly payroll and so on and so forth. So you wanna keep in mind from that perspective as well as an employer perspective. Okay, are you self-employed? You are self-employed person if you carry on a trader business as a sole proprietor or an independent contractor. You do not have to carry on regular full-time business activities to be self-employed. So in other words, it's possible for you to have a business that's kind of on the side. You might also have W-2 income and still be self-employed and therefore have to file basically a Schedule C for other types of jobs or income. Having a part-time business in addition to your regular job or business may be self-employment. So you still would have to file of course Schedule C and pay the government their share on that side job. So trade or business, a trader business is generally an activity carried on to make a profit. The facts and circumstances of each case determine whether or not an activity is a trader business. So that's gonna be the key point. It's carried in order to make a profit. So again, there's a couple things to keep in mind here. One is that you're doing the business your own. You're not basically working at the behests of somebody else entirely. Like if they have complete control over what you're doing, that looks like it's gonna be an employee, not a trade or business. And they should be treating you as an employee in that sense, which could be good or it could be bad, depending on the circumstances. But you also have the situation where you're engaged in something where you might be making some revenue, but it's not an activity that's engaged in for profit. And here, the government is concerned with people claiming losses. And this often happens with things that are kind of like fun hobby types of things, which you happen to make some money. And the traditional one, the big one that was, there was some cases on was horse racing and horse breeding type of things. Cause people tend to like to just deal with horses, I guess. So if you, so people were having these things where they were writing off tons of losses for horse racing and horse breeding and stuff, which it looked like was a hobby to the IRS after a while, because the losses get significant. So anytime you have those losses, if the government says, hey, you have a hobby now and it's not a business, then you're gonna lose the deductibility of all the losses, at least on the schedule C and have them severely restricted. So you do not need to actually make a profit or be in a trader business as long as you have a profit motive. So you might then ask the question, well, what if I have a loss? Then does that mean I'm not a trader business? No, not at all, because you could quite possibly have a loss, especially in the first couple of years of business. It's very common to have a loss. That doesn't mean you're not in it for the profit in the long run, because generally you're putting in an initial investment and basically hoping to generate revenue after a time. The IRS is gonna be skeptical of losses, however, because the IRS wants a cut of your revenue as your silent partner. They don't wanna cut of your losses. They don't wanna pay you for losses, right? They only want the upside, not the downside. So that means that you do have to make sure that if they were to audit you and you had losses that you wrote off against some other income, that you can prove that you were in it for profit. Now, usually the emphasis is on the government having to prove that you weren't in it for profit. And so you have kind of like the benefit, the innocent until proven guilty similarity and that instance. But if your losses go more than like three years or something like that, then the IRS could flip the position and be able to say, you know, now that burden is on you to prove that you're in it for profit because you've been writing off losses for over three years or something like that. So keep that in mind. You do need to make an ongoing efforts to further the interest of your business. Limited liability company, LLC. So now you get into different types of entities and this gets confusing because the sole proprietor is the easiest thing to set up. You just basically start doing business and you're in essence a sole proprietor. But you can get into say, well, what if I wanna set up a flow-through type of entity, in other words, not a normal corporation because the corporation has double income tax problems because you get taxed on the dividends, which are like draws, and you get taxed on the corporate level and that gets complicated. So you'd like a flow-through entity. The flow-through entities are usually a limited liability company or an S corporation that basically you file a separate return but the income flows through to your side of things on the 1040 and is taxed on your return. So you wanna know kind of the pros and cons of those and that gets into a lot of detail in terms of what's the best type of entity. Generally, you might wanna go to an LLC because you're trying to get some liability protection oftentimes or an S corporation with a corporate shield, they call it sometimes. But you can also kind of try to compensate with that with basically insurance that you would be purchasing as well. Obviously, if you go to an LLC or S corporation, it's gonna increase the burden in terms of the filing requirements. It's not as easy to do and to setting them up, you're gonna have to pay for the setting them up and actually closing them down is a difficult process too or can be, especially on the state side, depending on the state that you are in. So just a couple of things on that. We might dive into that in more detail later, but an LLC is an entity formed under state law by filing articles of organization. Generally, the income tax purposes, a single member LLC is disregarded as an entity separate from its owner and reports its income and deductions on its owner's federal income tax return. So the LLC normally would indicate that you have a limited liability company. It's usually kind of like a, you would think there'd be more than one person involved like a partnership kind of setup. It's a flow through entity, but you could have a single member LLC, which is an attempt to get the liability protection while still having the benefit of the ease of kind of like a sole proprietorship. So for example, if the single member LLC is not engaged in farming and the owner is an individual, he or she may use the schedule C. So you can still report on the schedule C in that instance. So sole proprietor, obviously if there's two or more people, then you typically would have to report on another tax return and have a flow through kind of system that would be taking place with the K ones. So a sole proprietor is someone who owns an unincorporated business by himself or herself. You are a sole proprietor for income tax purposes 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 the sole proprietorship in general is gonna be the easiest thing to set up if you just start doing business, you are in essence a sole proprietorship. And then again, if you wanted to try to get that added liability protection and still be in essence a sole proprietor and have the ease, you might look into the single member LLC. So are you self-employed and continued independent contractor, 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. Also, people who provide a service generally associated with the gig or the demand sharing or access economy such as ride sharing may be treated as independent contractors. So independent contractors. However, whether they are independent contractors or employees depends on the facts in each case. So you might have these kinds of situations where you could, these are some areas where you, the question could come up and you're saying, are they, should they be treated as an employee or should they be treated as an independent contractor? So for example, with these, the ride sharing kind of stuff and you're talking about platforms and the gig economy, then the government is kind of trying to pressure the system to try to say, well, they should be employees and not independent contractors. And the reason for that is, like if the government can categorize someone as an employee, force you to treat them as an employee, they have more leverage over the employer to report withholdings or make withholdings and report that information with W-2 information. If they're a contractor, then they have less capacity to get the payer, the employer, to in this case, the contractor or the payer of the negotiation to give the information to the IRS. All they can get is the 1099 in some cases. And with these gig economy things, it's even more complicated than that because really you're doing the work not for the platform, you're doing the work for the third party, the platform is just the intermediary. So the government, you can see the government's problem, they wanna lock down, they wanna have withholdings, they wanna have the documentation, they wanna know how much money people earned and to do that, they pressure the payer. And it's easiest to pressure the payer if you can force them into like an employee, employer situation, because then they can say, hey, if you want a deduction of the wages that you're paying, then you need to give us this information and do the withholdings and whatnot. So the general rule is that an individual is an independent contractor, if the person paying the work has the right to control or direct only the result of the work and not how it will be done. So when you're looking at that kind of scenario, you could see this in terms of you being the business owner or you being the person that's doing the work, if the relationship is basically here's the end result that I need, I need this house painted, I need it done within the next week and then you bring your own paint rush or the contractor brings their paint brush, their tools and whatnot, then it's more likely that you have a contractor situation. If on the other hand, you're bringing people in and you're the business owner and you're basically saying, I've got this one person who works for me the whole time and they basically, I give them the paint brush, I give them everything and I tell them exactly where to go and I'm there with them the whole time, it's more likely the government's gonna try to say that they're an employee. You can see that's kind of a gray area. It's kind of hard to make that designation in some industries. Obviously, if you're talking about someone who's like working in the office and you have complete control, they're on a nine to five job and they're coming in and you're doing whatever that needs to be done within a certain same location. It's pretty clear that the government's gonna say, hey, they should be categorized as an employee but if they're out there doing their own thing and they're basically doing their own painting jobs or something like that, but they're connected to you in some way as the intermediary, then it gets more complicated and you might have gray area where they could possibly be categorized as either an employee or a contractor but you wanna make sure that you're documenting it because if the government comes back and says that you categorized it wrong, then they can change things and basically, and if they say it was intentional, then it can cause problems. So the earnings of a person who is working as an independent contractor are subject to self-employment tax. So notice they kind of try to hedge over here when they write these things. They try to make it sound like being an employee is better, meaning if you're working for somebody and they want you to be a contractor, then they're somehow cheating you because you would be better off as an employee. But that's not necessarily the case because as we saw, the independent contractor possibly could write off their own business deductions and they don't have quite as much, you know, they're not restricted so much to the employer in that instance as well. However, obviously if you were an employee, then you would only have to pay half the self-employment tax. So there's pros and cons to being a contractor or not on both sides of the negotiation of the agreement between the two individuals. So to me it would be best if the government would kind of get butt out more, but that's not what they do. So there's pros and cons on both sides. So for more information on determining whether you are an employee or independent contractor, you can see Pub 15-A, you can find that in the IRS website, Employers Supplemental Tax Guide. Are you a statutory employee? A statutory employee has a check mark in box 13 of his or her Form W-2 wage and tax statement. Statutory employees use Schedule C to report their wages and expenses. So that's kind of more of an unusual type of situation so you still get the W-2 information, but you're gonna have that check box which means you're gonna report on the Schedule C possibly more likely than to be able to take the deductions in that instance.