 Income tax 2022-2023, business income part number one. 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. 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 than 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. Looking at the income tax formula, we're focused on line one income. Remember on the first half of the income tax formula is in essence an income statement, although just an outline, the scaffolding, other forms and schedules flowing into these line items. One of those being the Schedule C, which is in essence an income statement in and of itself. It having income minus expenses or business deductions get into the net income, which rolls into line one income of the income tax formula we see here. Page one of the form 1040, the Schedule C, rolls into the Schedule 1, which rolls into page one of form 1040, line number eight that we see here. Here's an example of a Schedule C profit or loss from business, where we see the income statement format of the income minus the expenses. That said, let's focus on the income side of things. Now we're looking at the business income. Remembering the general rule for income from the IRS's perspective. Anything you get is basically income unless the IRS has an exception saying that it's not income, right? So when we're thinking about our business income, the question is one, is this income? Two, is it exempt from us having to report it as income? And if it is income, where do I have to report it? Do I report it as business income on the Schedule C or possibly somewhere else on the form 1040 or some other form or schedule? That said, let's look at the business income introduction. This chapter primarily explains business income and how to account for it on your tax return and what items are not considered income. That's just as important to know what don't I have to include in there, what are the exceptions and gives guidelines for selected occupations. Clearly different occupations have their own different needs and categorizations and some specific items related to them. So if there is a connection between any income you receive and your business, the income is business income because you got it in connection to the business. Therefore, business income. So a business, you'll recall in the past when we talked about if you are self-employed or not, will depend in part if you're doing the activity in order to generate revenue. You have a profit motive as the motive for doing the business. A connection exists if it is clear that the payment of income would not have been made if you did not have the business. So you can have business income even if you are not involved in the activity on a regular full-time basis. So you might be saying, hey, it's only gig work. I got a little YouTube income. I got a little gig work platform income or whatever. It's not a big deal, but it's like business income even if you're not full-time. If you got another W-2 job, you still need to report the income, says the IRS typically, business income. So income from work you do on the side in addition to your regular job can be business income. For example, you may be in the business of providing services for a ride-sharing business as a second job. So you report most business income such as income from selling your products or services on Schedule C. That's where our focus has been, the good old Schedule C, in essence, an income statement. But you report the income from the sale of business assets such as land and office building on other forms instead of the Schedule C, meaning if you had something on the books that you had to, in essence, capitalize and record the depreciation and then you sold that stuff, the equipment, for example, you might have to report it on other forms to record the gain or loss for those particular sales as we saw in prior presentations. Presentation! So for information on selling business assets, you could see Chapter 3. We looked at that before. You got the non-employee compensation. Business income includes amount you receive in your business that were properly shown on Form 1099 NEC. Remember how the structure of the IRS works? This is an income tax system. That means income is, in essence, bad with regards to taxes. The government has an incentive to kind of get involved and look in, like, pry into your business to make sure you're reporting your income. They have the leverage to do that on the pay-er of a transaction. Therefore, if you are in a business where you work for another business as a contractor, as a sole proprietor, then that business will likely be sending you not a W-2, but a 1099, most likely a 1099 NEC. If you do business for, like, an end customer, you're a masseuse. You're a hairstylist. You work at a restaurant or something like that. The customer is not going to give you a 1099 NEC because you cut their hair, most likely, because the government can't make them do that, right? But they can make a business do that if you get income from another business. Either way, you still need to report the income from a legal perspective. But note that if you get a 1099 NEC, the IRS has, of course, the 1099 NEC, and they're kind of, they're looking into it in that way as opposed to traditionally before they got more intrusive and more intrusive. They used to randomly audit people kind of thing. It was a general way of keeping things in line. So this includes amounts, reports on non-employee compensation in box one of the form. So you can find more information in the instructions on the back of the form 1099 NEC you receive. Therefore, on the income line of your Schedule C, you would expect it to be at least equal to and most likely greater than the sum of all the forms 1099 NEC you have. If you put an amount on the Schedule C that's less than the sum of all 1099 NEC forms, it's likely the IRS will will automatically kind of question that because they're like, hey, wait a sec, I'm showing here my list of forms shows you have more income than you reported. That doesn't mean that your net income after expenses is going to be the same as those 1099 NECs. And that's often where small businesses run into a problem and that they don't report their taxes, meaning the government only has the income side, the 1099 NEC, and the government will actually come after you at some point and say, hey, look, you owe us money based on top line income, not net income because you didn't file your tax return and therefore you didn't give us the expenses. So that's another area that could come up that's to be aware of. So payment card and third party network transactions. So if you are in a business, you may receive form 1099 K representing total dollar amount total reportable payment transactions. This may not be the amount you should report as income as it may not include all the receipts and it may include items that are not included in your receipts such as sales tax. So the IRS is also trying to get involved. Notice that we have these gig work economies that are coming into play, which has skyrocketed the amount of like gig work small businesses that have come up, which in my mind is great. But the IRS wants to the IRS likes the structure of a smaller amount of big employers that have employees because they have leverage over the employer. So all these small businesses that sparkled up after this gig gig economy stuff isn't exactly what the IRS likes, right? Because they don't have, not only do they not have the control of an employee or employee situation there, they also don't have as much control to force people to give a 1099 because now you're working directly for the end customer, not for another business. So then they might pressure like the payment providers, the PayPal's, the credit card companies and so forth to try to get involved with issuing the 1099 situation. And so that's where you might have another kind of 1099 form, which would be reporting income. So business income deduction, income you report on schedule C may be qualified business income and entitled you to a deduction on form 1040 or 1040 SR line 13, C form 8995A or form 8995 to figure your deduction, if any. Okay, kinds of income. You must report on your tax return, all income you receive from your business unless it is excluded by law. That's the general stance of the IRS. Same as normal income is the same as business income. You got income unless the IRS says otherwise they want a piece of it. So in most cases, your business income will be in the form of cash, checks, credit card charges and so on. That's the point of cash. The point of cash is to have a measure of payment so that we can receive a measure of payment. So you're usually going to get paid in some form of cash denomination, right? But business income can be in other forms such as property or services. People often because we use cash so much these days think that if I get something other than cash, I barter, I trade, it's no longer income. That's not true. You still got paid and you got to figure out what the income is although it's less trackable, less traceable and less easy to understand or know what the dollar amount is because you're no longer using the ruler of cash to facilitate the transaction. But you can do that. You can trade and that might work in certain situations. So these and other types of income are explained next. So caution. So if you are a US citizen who has a business income from sources outside the United States for an income, you must report that income on your tax return unless it is exempt from tax under US law. So now if you're a US citizen, you have US income tax responsibilities, you're maybe subject to foreign tax as well in that case and hopefully the two countries have some agreement on how they're going to deal with that in terms of who's going to be basically benefiting from the taxes. That's a specialized type of situation that if you're living in the tax area, you could specialize in dealing with people that have income in multiple countries, for example. So if you live outside the United States, you may be able to exclude part or all of your foreign source business income for details. You could see publication 54 tax guide for US citizens. Why? Because obviously if the income was earned elsewhere, you might be subject to the foreign country's tax rates. And if that, if it wasn't the case, you'd be paying twice tax and that wouldn't be beneficial for citizens. So bartering or property, bartering. You can do a barter chain. Barter chain. I think trading, in other words, for property or services. Bartering is an exchange of property or services. So I do a service for you. I make a restaurant, give you meals or something and you do a service for me, whatever it is that they do. And we barter, we trade, we don't use cash. Okay. So you still have revenue generation. Now you got a value, how much you've received for income purposes that way. So you must include in your gross receipts at the time received the fair market value of property or services you received in exchange for something else. So if you exchange services with another person and you both have agreed ahead of time on the value of the services, that value will be accepted as the fair market value unless the value can be shown to be otherwise. So clearly most of the time the services being provided, you know, you would think are your standard services that have a fair market value and you would be trading them for services of an equivalent value if you're doing a free market exchange typically. So example one, you are a self-employed lawyer. You perform legal services for a client, a small corporation and payment for your services you receive shares of stock in the corporation. This reminds me of that, what was it? Daredevil movie where he kept doing work for like poor people and they fade them like in fish that the guy caught out of the, and stuff. In any case, that was just a side note. Let's back to the thing. You're a lawyer and payment for your services you receive shares of stock in the corporation. So you must include the fair market value of the shares in income clearly. So example two, you are an artist and create a work of art to compensate your landlord for the rent free use of your apartment. If I need that apartment, my apartment is timed. So you must include the fair rental value of the apartment in your gross receipts because now you were provided, you know, something, you were provided use of the apartment. So it's not like, you know, you would have been paying rent, right? So now you have to pay the value of the rent. So your landlord must include the fair market value of the work of art in their rental income. So they got the work of art and they paid for it, you know, in essence, not with cash, but with the apartment. So example three, you are self-employed accountant. Both you and a house painter are members of a barter club and organization that each year gives its members a directory of members and the services each member provides. Members get in touch with other members directly and bargain for the value of the services to be formed. So to be performed. So in return for accounting services, you provided for the house painter's business. The house painter painted your home. You must include in gross receipts the fair market value of the services you receive from the house painter. The house painter must include the fair market value of your accounting services in their gross receipts. Example four, you are a member of a barter club that uses credit unions to credit or debit members' accounts for goods or services provided or received. As soon as units are credited to your account, you can use them to buy goods or services or sell or transfer the units to other members. So we've got more complex kind of bartering situations where they are in essence creating their own kind of cash accounting system. So you must include the value of the credit units you received in your gross receipts for the tax year in which the units are credited to your account. They basically came up with another kind of form of cash in essence and that would be a form of valuation that you would think you got paid in something that you could buy stuff with which is kind of like cash. So then you would think you'd have to have enough that you got paid in. It would be income you would think. So the dollar value of units received for services by an employee of the club who can use the units in the same manner as other members must be included in the employee's gross income for the tax year in which received. It is wages subject to Social Security and Medicare taxes, FICA and FUTA taxes and income tax withholding. So not only you might also be connected to the Medicare Social Security. Okay, C publication 15 if you have that more complex example. Example number five, you operate a plumbing business and use the cash method of accounting. You join a barter club once again and agree to provide plumbing services to any member of a specified number of hours. Each member has access to a directory that lists the members of the club and the services available. Members contact each other directly and request services to be performed. You are not required to provide services unless requested by another member, but you can use as many of the offered services as you wish without paying a fee. You must include the fair value of any services you receive from club members in your gross receipts when you receive them even if you have not provided any services to the club members. All right, information. If you are involved in a bartering transaction, you may have to file either of the following forms. You've got form 1099B, proceeds from broker and barter exchange transactions. You've got form 1099 miscellaneous and you've got the, so these are the reporting forms for the bartering situation because you still have an income situation, a similar kind of process that you would have if you're paying someone, the IRS wants to pressure the payer to report the income to the person that received the income to double check that they report their income. So similar kind of process here. So for information about these forms you can see in the general instructions for certain information returns. Real estate rents. So if you are a real estate dealer with a real property on or on real property or an owner of a hotel, motel, et cetera, who provides services, made services, et cetera, for guests report the rental income and expenses on Schedule C. Notice the real estate gets a little kind of confusing because you might have like rental property which you might report on a Schedule E. The property however might be different than if you like own a hotel for example because if you own a hotel you're actively involved in the business. You're not as subject to those passive activity rules whereas if you have rental property then it's a Schedule E which is quite similar to a Schedule C in essence another income statement related to the rental property but it's sometimes going to have different like passive income rules whereas if you're Schedule C you have an active business that happens to deal with real estate like a hotel then you might report it on the Schedule C because it's similar to other businesses and you don't have you're not subject to some of those passive rules which are usually negative to you for taxes. So once again if you are a real estate dealer who receives income from renting real property or an owner of a hotel motel, etc. who provides services like made services that's one of the defining characteristics here that you're actively involved in what not for guests report the rental income and expense on Schedule C rather than you know Schedule E. So if you are not a real estate dealer or the kind of owner described in preceding sentence report rental income and expenses on Schedule E for more information see publication 527 residential rental property real estate dealer so you are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales rent you receive from real estate held for sale to customers is subject to self employment tax then which is a big hit on the self employment tax. However rent you receive from real estate held for speculation or investment is not subject to self employment tax. So another kind of interesting or messy kind of situation here is that if we're talking about business income if it's a for profit type of active business you're likely then going to be dealing with not only as we saw in prior presentations the federal income tax but possibly getting hit with the self employment tax which is kind of similar to payroll taxes meaning it's your self employment social security and Medicare taxes so then whenever you're thinking is this income if it's income then the next question is it subject to self employment tax which is a big could be a big tax right on the income or not so trailer park owner so rental income from a trailer park is subject to self employment tax. SE tax you are a self employed trailer park owner who provides trailer lots and facilities and substantial services for the convenience of your tenants. Notice that if you're actively involved the idea in my interpretation is that you are now doing an active business which means that you're kind of an employee of the business and so on and therefore you would be subject to the self employment tax which are kind of like the payroll taxes whereas if you're more of a passive income type of situation then you likely will not be subject to the self employment tax like when you make income like an interest income dividend income you're not subject to the self employment tax and if you have rental property that's more passive and you're not as actively involved then and you're reporting it on a schedule C versus I mean a schedule E versus a schedule C you may not have the same kind of self employment tax which is of course a big factor to consider if you're in like the gray area between those items so you are generally considered to provide substantial services for tenants if they are primarily for the tenants convenience and are not normally provided to maintain the lots in a condition for occupancy. Services are substantial in the compensation for services make up a material part of the tenants rental payments so now you're actively involved because you're providing those services that's the similar kind of concept we had with the hotel that was providing cleaning and so on. Example of services that are not normally provided for the tenants convenience include supervising and maintaining a recreational hall provided by the park distributing a monthly newsletter to tenants operating a laundry facility and helping tenants buy or sell their trailers so examples of services that are normally provided to maintain the lots in a condition for tenant occupancy include city sewage electrical connections and roadways hotels bordering houses and apartments rental income you receive for the use or occupancy of hotels bordering houses or apartment houses is subject to SE self employment tax if you provide services for the occupants generally you are considered to provide services for the occupants if the services are primarily for their convenience and are not services normally provided with the rental of rooms for occupancy only so now once again you've got the bordering houses kind of situation and the question is are you really kind of actively involved or not or is part of the benefit that you're providing going to be these services which means you're actively involved more likely to be subject then to self employment tax so an example of a service that is not normally provided for the convenience of the occupants is made services back to the made services as we saw with a hotel however providing heat and light cleaning stairways and lobbies and collecting trash our services normally provided for the occupants convenience prepaid rent advance payments received under a lease that does not put any restriction on their use or enjoyment our income in the year you receive them so we have another situation where we talked about before the accounting method a cruel method cash method even if you're on an accrual method sometimes when you have prepayments the IRS would like to deviate from that so they could have you could do the services in the future but they gave you the money in advance the government saying hey you've already got the money even though you haven't done anything for it yet you haven't earned it from an accrual standpoint we want our piece of it you have it on hand we'd like our piece of it now kind of thing so this is generally true no matter what accounting method or period you use accrual versus cash so lease bonus obviously if it was a cash method you're using then you would have recorded the income at that point anyways if it was an accrual method you wouldn't have recorded the income until you earned it but the government wants their money anyways lease bonus a bonus you receive from a lease for granting a lease is an addition to the rent include it in your gross receipts in the year received you've got the lease cancellation payments report payments you receive from your leasee for canceling a lease in your gross receipts in the year received then you've got the payments to third parties if your leasee makes payments to someone else under an agreement to pay your debts or obligations include the payments in your gross receipts when the leasee makes the payments in other words they didn't pay you they paid a third party on your behalf paying off your debts as the landlord that would be similar to them paying you and then you paid off your own debts so it's still income so a common example of this kind of income is a leasee's payment of your property taxes on leased real property and then we've got the settlement payments payments you receive in settlement of a leasee's obligation to restore the lease property to its original condition our income in the amount that the payments exceed the adjusted basis of the leasehold improvements destroyed, damaged, removed or disconnected by the leasee we've got the personal property rents if you are the business of renting personal property equipment, vehicles, form formal wear so now you're renting tuxedos or something like that include the rental amounts you received in your gross receipts on schedule C obviously those are not like something that you would report on a schedule E because you're clearly going to be actively involved in those kind of things you're going to have to suit people up in the tuxedo if you're renting that kind of stuff which means you're going to be subject to the self-employment tax and what not generally and reporting on schedule C but not subject to those passive income rules that sometimes on a schedule E you might be subject to ok prepaid rent and other payments described under real estate rents earlier can also be received for renting personal property similar situation with the prepayments then if you receive any of those payments include them gross receipts as explained in that discussion in other words the IRS wants their money when you get the money even if you haven't yet given the tuxedo or what not in a prepayment format so interest and dividend income interest and dividends may be considered business income so we'll continue on with that in future presentations