 Income tax 2023-2024. Are you self-employed? Get ready and some coffee so that you don't find income tax preparation to taxing. Most of this information can be found in publication 334, Tax Guide for Small Business for Individuals Who Use Schedule C Tax Year 2023, which you can find on the IRS website at irs.gov, irs.gov. Looking at the individual income tax formula, basically mirroring the calculation on the Form 1040, the first half of which is kind of like a funny income statement. Most income statements having income minus expenses resulting in net income. This income statement having income minus deductions resulting in taxable income. When we're thinking about a schedule C, we're focused on line one income of the 1040 income tax formula, which can be deceiving because the schedule C itself is basically a business income statement where we have business income minus business expenses, which are basically business deductions resulting in net business income from the schedule C, which will in essence roll into page one of the Form 1040 being represented here by our formula of line one income. Here's going to be the first page of our Form 1040. We're focused down here on line number eight, which is additional income from schedule one line 10. Here is our schedule one. 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 Accounting Rocks product line, if you're not crunching cords using Excel, you're doing it wrong. A must have product because the fact as everyone knows of accounting being one of the highest forms of artistic expression means accountants have a requirement, the obligation, a duty to share the tools necessary to properly channel the creative muse. And the muse, she rarely speaks more clearly than through the beautiful symmetry of spreadsheets. So get the shirt because the creative muse, she could use a new pair of shoes. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. An additional income and adjustments to income focused on line three, business income or loss, which is coming from the Schedule C. Here's an example of the Schedule C, which is a profit or loss from business which has two primary categories to it, like an income statement because that's basically what it is, income minus the expenses. Okay, so first question, are you self-employed? So this seems like a fairly straightforward question, but there's actually a lot of gray area with regards to this question. The IRS being quite opinionated about whether or not you are self-employed. Note the kind of incentives that you might have if you were basically the IRS. The job of the IRS is to try to track everyone and make sure that everyone is paying their taxes and try to basically be able to double check that people are paying their taxes. What's the best strategy to do that if you are the IRS? You're going to lean on the payer of every transaction to try to pressure them to give you the information about the recipient of income. Why? Because every transaction has two sides to it. You've got someone paying for something and someone that's getting the goods and services versus paying for the goods and services. The one that's paying for goods and services, if they are a business, is going to want to get a deduction for it. And therefore the deductions are good and the IRS therefore has leveraged over the person that is paying in any particular transaction by being able to say, hey look, if you want that deduction, you have to tell us who you paid and possibly make withholdings paying us on their behalf. And you can see this most clearly with a W-2 employee. So if someone is categorized as a W-2 employee, the IRS says to the employer, if you want that deduction, we want you not only to tell us about the money that you gave to the employee as income so that we can go after them giving us not only the employee but the government the W-2 form and we want you to actually physically take the money out of their paycheck before they even receive it in the form of withholdings. So you can see that would be ideal for the IRS. So they're going to lean towards people wanting to be categorized as employees rather than self-employed because as employees, they can pressure the employer to do the work for them, collecting the money and doing the reporting. So then the question is, well, do I want to be self-employed as an individual? You might ask that question, would it be beneficial for me to be self-employed or not? The IRS will try to argue that it's not because, again, they're kind of skewed towards wanting people to be in an employee or situation. The answer, of course, is that it depends. There's going to be sometimes it might be good, sometimes it might be bad. What are some of the pros and cons? Well, if you are a W-2 employee, in theory, the employer is paying for the expenses that you are dealing with and it should be easier to deal with in that regard. If you're self-employed, you're going to be basically paying for your own expenses. And you might say, hey, look, when I'm in an employee, I still pay for things that are expenses that I use for business and I should get a deduction for it. Whereas if I was self-employed, I would get those deductions. That's a benefit. You can write off the business deductions more easily as a self-employed individual than as an employee. However, on the downside, the net income that you receive as a sole proprietor could be subject to both self-employment and self-employment tax, which includes the employer and employee portion in essence of payroll taxes, social security and Medicare. So there's ups and downs, of course, to being an employee or being self-employed. It's not really cut and dry as to which you would be prefer if you could pick one. But the IRS, of course, is going to try to make it not cut and dry. But be able to say, you either qualify as an employee or you qualify as being self-employed. Obviously, in reality, there's going to be a lot of gray area where you might fit in either category. But that's what the IRS is going to try to do. And you can imagine that they're going to be tilted towards having someone categorized as an employee. All right, given that, are you self-employed person if you carry on a trader business as a sole proprietor or an independent contractor? That's the definition of basically being self-employed, right? You're self-employed person if you carry on a trader business as a sole proprietor or independent contractor. Now, note for taxes how easy that is to do because for taxes, if you generate revenue, any revenue is generally thought of as taxable income to the IRS unless they have an exemption for it. So if you go out and you just start like a hot dog stand or something like that, then the IRS is going to say, hey, you're a business. We're your silent partner. We want you to report that on a schedule C and give us our bit or part of that income. You might have all kinds of other questions like, well, what if I do I need a license for it and so on and so forth? Well, those are state questions typically in terms of what you need to do to be able to sell hot dogs in a particular place. But whether you qualify or not, if you did sell hot dogs and you make money from the federal government side of things, they want the money. Like even if you were in an illegal business, you're doing something illegal, then the government will still say, if you're Al Capone, the government will still say, we want our piece of your profits even if it's illegal, right? So the fact that something is legal or not doesn't stop you from, again, if you had income, then the IRS is going to say that you should be giving them part of the income, right? So caution. So you do not have to carry on regular full-time business activities to be self-employed. So you might be saying, okay, what if I only do it part-time? I have a W-2 job and I do some other stuff on the side. Well, the question is, are you doing it for profit? Are you making money with it? If you're making money with it, the government's going to want a piece of that. And basically if you're making money, then the government, you're probably going to see it as a profit-making thing. However, you might be saying, well, maybe I'm not making money. Maybe it's running at a loss. In that case, it is questionable. Maybe you do photography on the side and you're able to sell some of your stuff because you're good at it. Well, then the question is, if you write off all of your photography equipment, you might end up with a loss. The government doesn't like losses because when you have losses, you might be able to take those against other income. They want to be your silent partner when you earn money so they get part of it. They don't want the liability when you lose money because then they have to pay you, right? So that would be a problem. That doesn't necessarily mean that you're not a business if you have a loss, but then you have the question that will come up of, is this really a business activity or is it a hobby? If it's a hobby, you might not report it on a Schedule C, but rather report it as other income unlike a Schedule 1, for example, and be highly limited to the amount of deductions that you can have. If it's a business, however, you can take those deductions, possibly even have a loss that you can take against other income, but you need to be careful of that and make sure that you qualify because the IRS could come out and audit you and say, no, you're not a business, you're a hobby in that case, which would cause problems. So having a part-time business in addition to your regular job or business may be self-employment. Trade or business. A trade or business is generally an activity carried on to make a profit. So that's the idea. We're doing it to make a profit. Most people will bulk at that. A lot of people will say, no, I take photography because I am an artist and that's why I do these. Look at how beautiful this PowerPoint is. This is art that I'm doing right here. I'm doing this for money. Okay, I'm doing it for money. But some people might argue that they're not doing it for money. I like what I'm doing too, but okay. But the idea is that if you're doing whatever you do and you're also generating money with it, you're trying to do it well, people actually want to pay you for it, then of course the IRS is going to say it's a profit activity and they want a piece of the profits. If you're doing it at a loss, then again, from the IRS's perspective, it's a hobby, right? And we don't want to pay you for losses. You deal with your own hobbies. But if you make money with it, then give us a piece. So 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 to be in a trade or business as long as you have a profit motive. So that's where the question comes in on the loss side of things. If you have a loss, you don't want to be too scared of taking the loss against other income because that might be perfectly legitimate if you have a business objective of revenue generation. Most businesses have losses in the first few years. It's just that if you have like multiple years of losses, more than like three years, you can see why the IRS would then say, well, now the shift of needing to prove whether it's business or hobby goes to you possibly at that point in time. And in the event of an audit, then you'd have to make the argument, make the case that this is a profit-seeking business that I'm in. We just happen to have losses. We're going to make money possibly next year. It's going to happen. It's going to happen, man. So you do need to make ongoing efforts to further the interest of your business. So Limited Liability Company, LLC, and LLC is an entity formed under state law by filing articles of organization generally for income tax purposes. A single member LLC is disregarded as an entity separate from its owner and reports its income deductions on its owner's federal income tax return. Okay, so this whenever you get into a Schedule C type of business, you're going to have these questions that will come up as to whether someone should incorporate. Now, typically most small businesses aren't going to want to go to a C corporation, separate legal entity that pays taxes on the corporate level in part because there's double taxation. But you could go to like an S corporation or to a Limited Liability Company. Now, a Limited Liability Company is basically usually set up kind of like a partnership. So the idea of it would be if you had a partnership, for example, then you're going to have to possibly file a separate return usually unless it's like a married couple or something like that because in certain circumstances, which we'll talk about later, because then you're going to have to file a separate return so that the income will flow through from the partnership to the 1040s. So that becomes like just a technical thing that has to take place even though the partnership might not be thought of as a separate legal entity which will give some barrier hopefully or is the thought process of liability protection to the individual's assets. When you look at a Limited Liability Company, that's the idea usually of taking kind of like a partnership flow through structure but then also giving it some benefit of being a separate legal entity even though it's not taxed on the partnership level or the corporation level, it still flows through it. So they're trying to get the best of both worlds. But you might say, well, what if I don't have a partnership? I'm a sole proprietor. Well, then you might have a single member LLC and then it's like, well, if I have a single member LLC, do I need to really file a separate tax return which looks like a partnership tax return because the partnership tax return is usually a logistical thing I need to do so it flows through from the partnership tax return to the multiple partners. But if I only have one partner, what's the point of doing the separate tax return? So that's why you might end up with a situation where you have a single member LLC which basically is reporting things in a similar fashion using like the schedule on the normal income tax return possibly on a schedule C. So those are kind of questions that you want to ask in your particular state as well because some of these entity structures like an S corporation, an LLC, a partnership and a C corporation will have different pros and cons possibly depending on the state laws that they're incorporated in and that's why you'll often find different entities in different areas or incorporated basically in different states and what not and incorporated in different ways or using different taxable entities based on the industry but that's a little past the scope that we're going for here. So for example, if the single member LLC is not engaged in forming and the owner is an individual, they may use a schedule C. Okay, sole proprietor. A sole proprietor is someone who owns an unincorporated business by themselves. So you are also 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 once again if you have the LLC you could elect to have it treated as a corporation which is uncommon because that's what you're trying to avoid typically with the LLC because it could result in double taxation. So the sole proprietor is someone who owns an unincorporated business by themselves. Independent contractor. So 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. Auctioneers. That's what I was trying to say. That's what I was trying to say. So however, whether they are independent contractors or employees depends on the facts in each case. 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 when we're thinking of the category of independent contractor, we're focused more on these service items, right? Doctors provide services, dentists, veterinarians, lawyers, accountants, contractors, subcontractors. So if you think about something like a lawyer or an accountant for example, if they're doing work they are providing their labor. The question could come up then, well if they're providing labor are they an employee to the person that they're working for or are they an independent contractor? You could have gray area in many cases, but the general rules that they lay out and we might go into some of these more rules in more detail later, but the general idea would be if you're working for someone and they have control over how you're doing the work, the more control they have, the more it looks like an employee-employer situation. If on the other hand they give you a job and a deadline and you do your own work and achieve it on your own time, on your own schedule using your own resources, you would think you would be more likely to be an independent contractor categorization in that case. Also remember when we're talking about employees, we could be an independent contractor with employees of ourselves. The question here is whether we are an employee of somebody else. Being a Schedule C or someone that reports on a Schedule C doesn't mean that you don't have employees. You could, if you need help then the question is going to be, there's a couple ways you can get help. You can try to get a partner or some kind of equity interest or something like that, which takes up resources in terms of them being able to have some say in your business or you can hire an employee possibly, in which case you have more control and they don't have the say of what you're going to do within the business. You might be able to take a loan if you need financial, just financial help. That's another resource to it or you might be able to hire a contractor yourself, in which case you run into the same problem here with someone that you're hiring. The person that you're hiring, do they qualify as an employee or as a contractor? The earnings of a person who is working as an independent contractor or subject to self-employment tax. For more information on determining whether you are an employee or an independent contractor, you can see Publication 15A Employers Supplemental Tax Guide. The IRS tries to make this kind of like a black and white decision as we saw. If you're in a situation that you don't know if you're a contractor or not, then what you want to do is think, would it be beneficial for me to be a contractor or not, what would be the pros and cons of each, and then set up your situation accordingly, making sure that you understand the rules that outline whether or not someone is an independent contractor or not. Also remembering, when looking at IRS resources, they will tend towards saying it's better to be an employee because that gives them more control. It might be better in your circumstances to be an employee because of benefits and so on and so forth, but it might not as well because independence is nice as well as being able to deduct expenses and whatnot. So are you a statutory employee? So a statutory employee is a check mark in box 13 of Form W-2 wage and tax statement. Statutory employees use Schedule C to report their wages and expenses. So this is kind of a hybrid or exception situation noting that if you're a W-2 employee, one of the downsides is you don't typically get to write off your expenses. That's the problem, but possibly in this situation you would be reporting on the Schedule C. So that's somewhat more of an unusual situation. So if you fall into that situation, you want to dive into it in a little bit more detail if you qualify as a statutory employee.