Recently, I did an interview with Mark Wilson, a pro tax accountant. Our goal was to help our tens of thousands of freelance educators, instructors, artists, musicians, and creatives with tips and tools they could use to help prepare taxes. The video below is the complete segment, followed by a transcript in case you want to follow along.
Transcript – Steven Cox – Let’s Talk Taxes
STEVEN COX: Hey, we’re live. Welcome, everybody. It is 9:00 and we are doing a webcast for you today called Let’s Talk Taxes.
MARK WILSON: Nothing more exciting.
STEVEN: Man, you like get up early in the morning. What do I want to do? I want to talk about taxes.
MARK: Yeah, this is usually how I put my wife to sleep at night – I talk taxes.
STEVEN: That’s awesome. Hey, so I’m here with Mark Wilson. Mark is a one million year veteran of tax law. He’s been practicing for about 20 years in San Diego dealing a lot with personal taxes, corporate taxes, business taxes and helping people just like you learn how to pay their taxes appropriately without, of course, paying too much. I’m sure you find a lot of folks end up paying too much for taxes?
MARK: We see that or they take too many deductions and then they’re in trouble so it goes both ways. But yeah, a lot of people pay too much in taxes.
STEVEN: This is one of the most important areas for you. I think as you’re looking at yourself as a small business, you are running a business, and one of the keys is not only the income side of the business, generating income, the second key is making sure you’re controlling your expenses, and the third piece I really believe is the management of taxes and knowing how to deduct what the government has accommodated and given you the benefit of knowing and actually taking these deductions means one of two things. Either if you know this information and this knowledge the money ends up in your pocket. If you don’t understand these things and you don’t know this the money ends up in the government’s pocket. So the question for you is which pocket do you want your money to go in?
MARK: Hopefully their pocket.
MARK: When we meet with entrepreneurs we talk to them about what their goals are and what they’re trying to accomplish. Often they are paying too much in taxes and as a general question we always get – what can I deduct. What type of expenses can I deduct? From a 30,000 foot view, the easiest way to answer that question is anything that is related to your business, anything you spend money on to make money will be deductible. So that’s true for most items but I know we have some questions that maybe people have sent in but we can go through some of those.
STEVEN: Sure. Yeah, we got a ton of questions in from the audience, very close to 100 questions. Obviously we won’t be able to answer all of those questions but I’ve divided them up into three main categories to help us out. We’re going to cover all three of these. At the end of this presentation you are going to be armed with more knowledge than you’ve ever had about taxes.
First, I want to also start by saying that TakeLessons, Mark, or Mark’s company is not giving you personal advice. We highly recommend that you get your own tax accountant to handle your own personal situation. Everyone’s situation is different so as a disclosure, indemnification, we’re not personally giving you tax advice. My attorney said we had to say that.
MARK: That’s important. That’s important to say.
Three Areas to Cover
STEVEN: Cool. What we’re going to cover, there’s three main areas. The first one is questions about company structure – do I need an LLC versus a corporation, those types of questions. The second set of questions was on deductions, one of our favorite topics. We’ll dive in deep onto that. Then the third is around organization – how do I get organized so I’m sure that I pay as few taxes as humanly possible. We’ll over those in that order.
Thank you for all your questions. First of all, we’re going to start with just a TakeLessons specific question. This came in from one of our tutors, Barbara, Barbara Ellis Warrock. I’m not sure where Barbara’s from but she wanted to know, “How do I make sure that TakeLessons is paying my corporation instead of me?” This is tied… We have instructors fill out a W-9 form and there’s some items on the W-9 that if they fill that out correctly then they’re paid as their corporation instead of them personally. What do they need to check there?
MARK: The most important part is put the right tax ID number on that form. As long as they put the corporate tax ID number on that form and give that to you guys, then they’re going to get a 1099 with the corporate tax ID.
Another question a lot of people have related to that they’ll ask is, “Is my corporation even supposed to get a 1099?” The answer is they’re not required to get a 1099 if you’re a corporation. However, it doesn’t hurt if you do so a lot of companies best practice is they’ll send out 1099s to everybody that they cut a check to over $600 and they’ll send out a 1099. If you’re a corporation, just make sure you get the right tax ID number on your form when you fill it out and send it in to you guys.
STEVEN: That’s normally called an EIN number.
MARK: Yes, your EIN tax ID number. Yes.
STEVEN: Perfect. Let’s jump into company structure. We had a bunch of folks, Michelle Arthur-Cohen, Cheryl O’Neil, they all asked around… I’ll read you the general thoughts then we’ll dive into it.
The questions are how do I go about deciding what sort of business entity do I chose, what are the pros and cons of each, are there things I can deduct if I’m a sole proprietor versus an S Corp versus C Corp, these sorts of questions. So for most of our folks, they’re single source businesses. How do they go about deciding which corporate structure is right for them?
MARK: Most individuals, it really has a lot to do with how much money they’re making. It’s a big part of it. If you are an individual and say you’re making $50,000 in self-employment income, generally speaking it’s probably better that you stay a sole proprietor or if you’re worried about any kind of liability being an LLC. The reason is because there’s additional costs that go into having a corporation and there’s additional costs for having an LLC.
But if you’re going to make more than that, as you start to get to the $70,000-100,000 range, we’ll start looking at whether or not they need to be an S Corp. The reason is individuals, sole proprietors, will pay self-employment taxes on all their net earnings. LLCs will as well. They get taxed the same way that a sole proprietor except they get an additional tax but what you get with an LLC is you get limited liability. So if you’re worrying about being sued or you want to protect assets, there’s risk in your business, then that’s a reason to have an LLC.
An S Corp is a really good option if you’re going to be making more than to that $50,000. Fifty thousand is right at that borderline but more in that $70,000-100,000 and above because self-employment taxes equal 15.3% of your net income. What that means is whatever you’re left with at the end of the day, whatever your net number, the number at the bottom, you’re going to pay 15.3% self-employment taxes plus your ordinary income taxes.
So if you are in the 15% tax bracket, you’re going to pay 15% tax on that money plus you’re going to pay 15.3% in self-employment taxes plus whatever your state income tax is, depending upon where you’re at. That’s really expensive earnings. It’s the most expensive earnings, the most tax, the highest tax you’re going to pay.
Self-employment taxes are really just Social Security and Medicare. When you work for somebody the employer will pay half of Social Security and Medicare and then you pay the other half and it gets deducted out of your net paycheck. You don’t have to do that if you’re an S Corp. The net income of the company will flow through to you and you’ll pay tax on that money but it won’t be subject to the self-employment taxes.
The catch is you have to pay yourself some W-2 earnings. It makes it a little bit more complicated. You have to run payroll now that you may not have had to run before. You have to file a corporate tax return so you generally have to pay somebody like me to do a tax return like that and you’re going to pay a minimum tax to the state. If you’re in California, it’s 1.5% of your net income or $800 – whichever is more.
It really comes down to how much money are you making and at what point should you switch from being a sole proprietor to an S Corp. I’m not a huge fan of LLCs in this type of structure because you’re going to pay tax on that money and there’s no real tax savings in the LLC. You only are protecting yourself from litigation. You get that same protection with an S Corp.
A C Corp is really, that’s if you’re going to have foreign investors or if you think you’re going to take your company public or there’s going to be some other money raises or other type of things. That’s really a more complicated structure and you pay taxes twice in a C Corp. For a small company, smaller individuals, and I think our audience we’re talking to today, it’s either a sole proprietor or S Corp are the two decisions and then you can go from there.
STEVEN: Just for clarity, for our folks out there, you’re recommending two structures. The first one is sole proprietor in which you don’t file and set up a corporation per se and the benefits of that is first of all it’s cheaper, right?
MARK: It’s cheaper administratively, yes.
STEVEN: Cheaper, it’s less forms to fill out, the income passes through directly to you. The negative to that, the big one is your liability. With a corporation there is a shield, a legal shield, so if something happens people can sue the corporation instead of suing you personally which is something to keep in mind. I don’t know if anyone out there has been sued or whatever the case is for someone in their home or something like that. I could see the benefit of that. From a straight tax perspective, it might be more beneficial if you’re making $50k or less, $60k or $70k even, to go personal.
MARK: The reason is because the taxes that you save by not paying that 15.3% get eaten up in fees to CPAs and to paying taxes and paying payroll companies to run your payroll so the administrative cost is a little bit higher on the S Corp. But if you’re making $100,000 a year that’s $15,000 extra in tax you’re going to pay and you certainly won’t have that in administrative costs. So that’s the decision.
I think part of that question you asked – are there items that you can deduct as an S Corp or an LLC that you can’t deduct as a sole proprietor. The answer is no. If it’s deductible from one entity it’s deductible for another entity. Businesses can deduct pretty much the same across the board regardless of the entity structure. That’s a common misconception that I can deduct more if I’m a corporation versus if I’m a sole proprietor. We hear that a lot.
STEVEN: That’s good information. That takes us to our second topic. First of all, Maria, are there any questions so far on that particular topic?
MARIA: There is a question from Jill. Is there any sort of litigation that we, as lesson instructors, should be worried about?
MARK: That’s a great question. I would answer that by saying talk to your attorney.
STEVEN: Talk to your attorney, right.
MARK: That’s a really difficult question to answer because people can sue you for anything that they feel like suing you for. I don’t know if you’re in an environment that’s super risky.
STEVEN: Obviously you want to make sure that if you’re running your own studio that you don’t have things laying around on the floor so people can trip on them, these sorts of activities. Just run a good business would be the best thing and obviously have your own liability insurance.
MARK: I think most liability in service related work regardless usually comes down to billing. People don’t want to pay a bill or there’s something you can deal with without attorneys. Anyway, for protecting assets, that a decision that I think the viewers have to make.
Tax Deductions for Freelancers
STEVEN: You talked a little bit about deductions, Mark, and this was the area where we got the most questions so we’re going to dive into some of these particular questions. The bottom line is as you’re out there creating business and you’re producing income there are costs associated with producing that income. Well dive into details, normally those costs are deductible off of your income.
We’ll jump into a few questions. The first question was along the automobile. Rosita, Patrick, a whole bunch of people had asked questions about cars. Let me read through a few of these and then we can jump into car deductions. If I’m a 1099 contractor, which is what we are here at TakeLessons, can I write off gas when traveling to a student’s home to teach? How do I figure out mileage to and from a client’s home? Can I write off part of my car payment? What about insurance? What if I wash my car? Anything to do with automobile, how do you normally advise clients?
MARK: Automobile is a special type of deduction so there are special rules associated with automobile deductions. The IRS, and California adopts their rule, says that you need to have a mileage log to take a deduction and if you’re driving your personal car for work then the mileage that you track is going to be the source of allowing you to take that deduction. So you’re supposed to keep a mileage log.
You get to deduct either your actual expenses related to that percentage of business use… You take the total miles you drive and you take the total business miles and you come up with that ratio and then you multiply that ration times either your actual expenses or whatever the IRS your deductible per mileage deduction is.
You get one or the other. Somebody asked, “Can I deduct the gas?” The portion is for business use. You would take your total expenses for all your gas per year and then you would multiply that ratio times that. Or you take the IRS deductible allowable per mile you get to deduct. Am I explaining that right? I think I got confusing there.
STEVEN: Let me grab a board. I’m going to write this out just for our audience members. Look at this. We’re going whiteboard on you. I want to make sure our folks understand. Maria, make sure that you can see my writing on this. Okay?
Let’s say I drive 1,000 miles during the year. Can you see that? A thousand? Or no? If you can’t that’s okay. Maybe I can just talk about it.
MARIA: You might need to make it darker.
STEVEN: We’re going to make it bigger. I drove 1,000 miles. Out of this 1,000 miles, half of the time I was using the car to go back and forth to clients. So, I have 500 miles that I’ve used to drive back and forth to clients to go teach them. What this means is that basically half of my car was used in business expense. So that equals 50%. What that means then is if I have spent $100 on gas I can deduct 50% of that, or 50 bucks, off of my taxes and auto insurance or car washes or anything like that at all.
MARK: Repairs and maintenance, vehicle registration, all of that.
STEVEN: This is why it’s really important to keep the auto logs because if you’re using your car 60% of the time or 50% of the time or 100% of the time for business, all of those expenses in accordance with the percentages can get written off against your income.
MARK: Every year I have clients come in. I’ll say how many miles did you drive last year as a deduction and they always tell me this.
STEVEN: Same as last year.
MARK: Yeah. I don’t know if you can see that or not. This is not enforceable with the IRS so it’s really important to keep a mileage log. It’s the only way to guarantee that you get the expense. We’ve had lots of clients be audited for this. Creating a mileage log after the year is over is really difficult but if you keep a log during the log it’s not that big of a deal. It’s an important expense and it’s usually a pretty good one.
More times than not, the IRS published deductible per mile deduction is generally comes out ahead. So if you just keep track of your mileage, take that as your expense. A lot of people want to make their lives easier. They don’t want to keep all their gas receipts and all of their payment and all of that. If you just keep a mileage log then you can take that against whatever the IRS published rate is. I think it’s right around 32 cents.
STEVEN: Mark, if I’m not mistaken, the big key like you’re said and it’s very important, keep the mileage log. Right? As long as you have done that then at the end of the year you can work with your professional tax advisor and they can take a look at your expenses, they can take a look at what the IRS allows, and then guide you on which path to choose.
MARK: That’s right.
MARIA: John mentions that there is software and smartphone apps that you would be able to keep track of that mileage.
STEVEN: Great. Does he have a particular app that he recommends.
MARIA: He said he does not but I’m sure we could find one in the app store.
STEVEN: Just go to the app store. Find mileage log or auto mileage log or something like that. I’m sure you could find something like that.
MARK: I’d say if you keep an electronic calendar, you could put the mileage log on that calendar. What’s nice about that is it tells you who you met with and so you have additional back up for that. Then I would print those out at the end of the year and keep them in a PDF because sometimes our digital calendars get destroyed or you upgrade your computer and that historical information goes away. That’s another good source.
If you do get audited the IRS will try to test the reasonableness of the miles. What they’ll do is they’ll look at some of your maintenance receipts to see how many miles you drove between oil changes and other things. If you worried about it that’s an additional step to protect yourself.
STEVEN: Good point. Who gave that recommendation? Was it John?
MARIA: John mentioned the app.
STEVEN: John who?
MARIA: John (unclear/Everal?? 00:21:12).
STEVEN: John, thank you. You will be sent a pair of these handy dandy, unbelievable TakeLessons sunglasses for your help. Thank you. All right, next question.
MARIA: There were two recommendations for apps also – TripLog for Android if anyone has an Android phone and then MileIQ. It doesn’t say which system that’s on.
STEVEN: So it’s TripLog for Android. If you’re on an Android phone look up TripLog. And?
STEVEN: MileIQ for potentially both platforms.
MARIA: Yes. Then Heather would like to know what about the cost of purchasing a car?
MARK: If you’re purchasing a car, it’s the same story. If it’s 100% going to be for work you can deduct the purchase price under section 179, which has not been extended. Up until 2014 you could have deducted up to $500,000 worth of major purchases.
STEVEN: That’s an expensive car.
MARK: Yeah, well, it wasn’t just the car. There are special rules for cars but it’s not that high this year. But yes, if you purchase a car you can deduct that and it’s generally over five years. So whatever your purchase price is, you take it over five years if it’s 100% for work.
If it’s not 100% for work you’re going to still need the mileage and you’ll have to use the ratio to determine the deductible portion and it will be measured on an annual basis.
STEVEN: Got it. Let me ask one question for clarity purposes around automobiles. There’s a difference between buying the car and leasing the car. My understanding, and correct me if I’m wrong, is that if you’re leasing the car then that is an expense because you don’t own the vehicle and then those ratios that we wrote earlier on the board would apply. If I’m using that car 50% of the time for business, I write off 50% of my lease payment as a deduction.
MARK: Or the mileage deduction. Whichever is higher. Yes. If you’re purchasing the car and you’re financing it then the interest would be the deductible portion, not the principle portion of those payments.
STEVEN: Right. Got it.
MARIA: Then along those lines, Geo mentions he’s in New York City so buying a bicycle or using a Metro card, is that anything that would be able to be applied?
MARK: Absolutely, if he’s using that to drive around. The percentage that he’s using, spending that money, for business is absolutely deductible.
STEVEN: So if you buy a bicycle, Metro, your use of Lyft or Uber and you’re getting back and forth to clients, then all of those are deductible expenses as well.
MARK: Yes. Absolutely.
STEVEN: Super. The next line of questions, still under the deductions section, is on gear and supplies. Jason Martin, he’s one of our very early instructors out of the hundreds of thousands that have signed up – I think he’s in the first 100 actually. Jason, hey, how are you. He has a story probably similar to a lot of people out there. I’m going to quote from him because it’s pretty cool.
He said, “I own my own music school.” It could be language school or sports instruction, whatever the case is. “So I own my own school and it seems like I make close to zero after buying all the gear and crap that I need to actually run my business.” That’s very true. You think about the sports coach who has to buy gear and protective gear and soccer balls or whatever the case is. In Jason’s of course is his music business. He has to buy a guitar or an amp or these sorts of things. So his question was, “Can I deduct the gear that I use that I have to buy in order to teach?”
STEVEN: There you go.
MARK: Absolutely, you can deduct it. Back to what I said, Section 179. Section 179 is a special rule that says if you’re buying equipment that has longer than one year useful life that you can deduct the full amount of that purchase in the year that you buy it. So for 2015, it’s $25,000. I say it’s only $25,000 because it used to be half a million dollars. You can deduct the full amount of that equipment in the year that you buy it.
If that is not enough, the remaining portion of what we call depreciated value of those assets would go over their useful life. It depends on what type of asset it is. If it’s equipment that you’re using for your business it’s five years. If it’s a table and a chair that’s seven years. It just depends on the exact type of equipment it is but the general rule is if you’re buying equipment and 179 was not there you have to depreciate that over the IRS determined its useful life.
STEVEN: Got it. So right now the tax code has an accelerated system set up. For most folks out there the $25,000 threshold is pretty good.
MARK: Under 179.
STEVEN: Right, so in Jason’s particular case if he goes out and gets a new amp and he buys a new (unclear 00:26:46) and he needs a new keyboard and then buys sheet music, and a fact that you mentioned, needs a desk for the computer system, needs a chair for his students to sit in – all of that should be deductible under these sorts of things.
MARK: That’s right. I would say that sheet music is different than a guitar for guitar lessons because sheet music, I would classify that more like a supply that’s going to be used up in a year. You’re probably getting sheet music, you’re writing on it, you’re giving it to a student, the student might take that with them, it’s gone. It’s not going to last longer than a year but a guitar is going to last maybe a lifetime and so that’s a different type of expense. I would put the items that are going to be used up within 12 months in a different category than what I would call assets. Assets are things that last longer than a year. So sheet music, supplies, ink cartridges, that sort of thing, you’re going to use that up within 12 months, deduct it. Pencils, paper, all of that.
STEVEN: So deduct away. Yes, Maria?
MARIA: With that, Elizabeth actually points out music books, considering that those last a little bit longer than sheet music and then Heather has a great question in regards to what if she bought equipment before she actually went into business?
MARK: She can put that into the company as of the date that she started that business. So you can contribute assets to a company as long as you have not deducted them already through a previous business.
STEVEN: So, let’s say you own a guitar or let’s say you own ten guitars, which a lot of folks out there probably do, and they start a teaching business. They haven’t deducted those purchase prices before. When I start that teaching business then I can basically take the cost of those and deduct that against my first years income then?
MARK: That’s correct.
STEVEN: Wow! What an unbelievable cost savings.
MARK: Yeah, huge.
STEVEN: That’s thousands and thousands right there.
MARK: That’s huge. Yeah, so you can contribute that. That’s as if you put money into your company to start your business. Money is an asset, right, so you put the money in your company and if you didn’t have those guitars you’d have to go buy them to start your company. So it’s as if you put the guitars in your business and now you’re going to use them in your business. It’s the same as cash really at the end of the day because you’re using those to run your company.
STEVEN: Wow, so if you haven’t deducted those expenses before this is the year.
MARK: That’s a common missed item. That’s a great question. That’s a really good question.
MARIA: With that, actually this is a great one from Carl on top of that. Do you have to have individual receipts or can you simply print out a purchase history from a company?
STEVEN: The question is do you have to have receipts or can you use a purchase history like if they bought all of their items at Amazon, for instance.
MARK: Anything that supports your purchase is good to have. Of course, you need that if you get audited. The IRS will take testimony and they’ll measure whether or not it’s reasonable also. So best case scenario you have backup either from Amazon or a receipt. If you don’t, we’ve had audits before where a client might not have receipts but we take pictures and say well these things just didn’t appear. They spent the money, they paid cash, they don’t have any receipts of it. That has worked. I won’t say it always works but it can work.
STEVEN: I was talking to a friend along those lines, I was explaining our tax talk here and we were talking about the receipts. He said, “Well, yeah, I was going to write off this item,” I think it was actually a keyboard, “and I lost the receipt so I didn’t.” I think that’s a common misconception that is if you don’t have a receipt you can’t write it off.
MARK: Yeah, that’s not true.
STEVEN: It’s not true, right?
STEVEN: It basically helps with proof in case you get audited but one doesn’t proceed the other with respect to having to write it off.
MARK: That’s right. That’s right. If you’re spending money for your business, you know you spent the money, then deduct it. I mean you should deduct it. Then if you do get audited and the IRS refuses to accept it then you’re just going to pay a little bit more in taxes.
STEVEN: You’re not going to jail over it.
MARK: You’re not going to jail. You don’t go to jail. You just…
STEVEN: Lose the deduction.
MARK: You lose the deduction. You might have to pay some interest but…
STEVEN: Right. Okay, great. Next, under gear and supplies, Heather, Patrick, and Jessie and a few other folks asked about cell phones and these sorts of items and phone bills. The question, “My husband and I share a cell phone bill but we have separate phones and approximately 25% of my usage of my cell phone is for my teaching business. Can I deduct that percentage off of my phone bill as a business expense?”
MARK: Absolutely. You want to document your method for why you took the deduction, which is a tough one, right because you’re not keeping call logs because that would take a lot of work. Like I said, the IRS will take testimony. They will measure whether or not it’s reasonable or not. I don’t know about you, I don’t even have a home phone anymore. I have a cell phone. I have a cell phone that I use the vast majority is with clients or my wife. That’s what I use my phone for. Yeah, they will accept that.
STEVEN: What about the internet? A lot of our instructors are teaching online. In fact, close to half our instructors teach online. Obviously you need an internet setup, they have to buy a microphone or a camera. What about internet expenses?
MARK: Internet expenses are also deductible if you’re using it for work. You do need to be careful. It’s an item that the IRS will look at if they think that you’re taking 100% of it and it’s at your home and they know everybody goes on the internet for personal use. At our firm, we will ask how much are they spending on their internet and we get an idea of how much time they use it for work versus personal and then we take a position. Sometimes in taxes you just have to take a position. That might be 75% of their time they’re on the internet, we take 75% of their internet costs as a deduction.
STEVEN: So it sounds like what you’re saying is be reasonable with those sorts of expenses.
MARK: Be reasonable and usually the internet is not a massive deduction so it’s not a big risk item because of that. Cumulatively, and we can talk about risks later on, some of these expenses, but you sometimes just have to take a position.
STEVEN: Makes sense. Question, Maria?
MARIA: Yes. Barbara has a great question along with this. Do the expenses have to be from the actual business account or can they be from various credit cards that are personal?
MARK: Love that question. Okay, so the answer is it doesn’t have to be through the business account but we recommend always if you’re paying for any business items through your personal account that you create an expense report as if you worked for a company so you can detail what those expenses were and attach a receipt and so as if you were reimbursing yourself.
The reason is is we always recommend people that are self-employed have a separate bank account. More times than not they don’t, especially a small sole proprietor. They’ll just kind of mix it all together which makes it difficult for accounting purposes and also allows if you do get audited the IRS to go ahead and look through all your personal expenses.
MARK: So I recommend having a separate account for that and it’s better to pay it through your business account but it doesn’t make it not deductible if you pay it from your personal account.
STEVEN: Let’s dive in. So at the very base level, if we have folks that are just sole proprietors, they own a small tutoring company that’s just them, you’d recommend that they set up a business account and in order to do that they may or may not need a business license from the city.
STEVEN: Sometimes you don’t even need one. You just go to the bank and say I’m setting up in this case Mark Wilson Tutoring Company, set up a separate account with your bank, and then any business expense you have through there, just run them through that. If you have something on your personal account then expense back just like you would regularly and have your business account pay yourself back. But the more you can separate those two, the easier your life becomes at the end of the year and also the cheaper your costs to your accountant is because there’s less work for them to do.
MARK: And less headache for them personally, right, because it’s all in one spot. I’ll anticipate another question that they might have. If they have the business account and they’re just starting, how do they get the money back? Right?
All the money is going into the business account and they are paying their expenses and then at the end of the day they have what’s left over, right? You just write that check to yourself and then put it in your personal account. Just whatever’s left over and that will be called a distribution and that just goes to the business owner. The distributions are not deductible.
STEVEN: Got it. Darn it. So the last line of question on deductions is about home or rent, the place where you live. The majority of our instructors out there have a studio in their home that they have set up in order to teach out of. So how would they go about, in fact, how do I calculate how much I can deduct from my rent or mortgage based on where I teach and the size and this sort of thing?
MARK: That falls under home office deductions. Home office deductions are based on the square foot that is dedicated to your business. If you have a 3,000 square foot home and 1,000 square feet of your home is dedicated to your business, then a third of all expenses associated with your home are deductible.
STEVEN: Wow. Okay, so 3,000 square foot home, big home, you got 1,000 square foot studio, awesome size studio, so that means a third of my rent is marked off, a third of my utilities, a third of my home insurance, a third of, if I have a mortgage, a third of the interest that I pay is all deductible against the income associated with that business.
MARK: That’s correct. The way home office works, it will create an expense and it will go over to your Schedule C, which is where a sole proprietor files their tax return, and it won’t allow a loss. It won’t make your net income as a net loss. It only will bring it to zero. A lot of times those expenses are much higher than what the business income is going to be. So simply with the home office you can wipe out your net income often and not pay any tax.
STEVEN: That’s an important point. When he says wipe out your net income, you’re still earning income but your tax liability literally drops to a big fat zero. Nothing.
MARK: Zero. Donut.
STEVEN: How would you like to pay donut. That would be pretty cool, right?
STEVEN: That’s why when I go back, when I talked at the very beginning, three parts of your business – income, expense, and then the third category is really understanding and working with a professional on taxes because it can make a world of difference of how much money ends up in your bank account. It’s really important.
MARK: Yes, it’s important.
STEVEN: Yes, another question?
MARIA: We have a few questions on the studios. Heather asks does it qualify in utilities as a business expense require the structure to be physically separate from the house?
MARK: No. The total utility expenses would go on the same form and what that 1,000 square feet for your studio versus 3,000 square feet for your house, it creates that ratio and all of your expenses for the whole year go on that home office form and then carry over to your Schedule C.
STEVEN: Using that as an example, 1,000 square foot office so a third of all my…
MARK: Your utilities.
STEVEN: So if I have $1,000 in utility bills for the year, I write off $333 of that immediately, right out of the gate?
MARK: Right, as long as it doesn’t create a loss in your business, it just brings it to that zero.
STEVEN: Donut. Yes?
MARIA: You had mentioned, just backing up a little bit, he doesn’t know whether it’s beneficial or necessary to file a DBA.
MARK: It’s not required if that’s what he’s asking. You don’t have to file a DBA. You can be Mark Wilson, teacher and be in business. Generally speaking, however, if he’s going to have a separate bank account, most banks will require them to file a fictitious name filing and some publication, a business journal, or some publication to open up a bank account So by doing that he’s kind of filed a DBA at that point.
STEVEN: Right, and if I’m not mistaken, it could be each city or each state certainly has their own rules around this particular piece and you have to look at your particular city and state to have the correct answer to that.
MARK: That’s true. That’s the same with business license. I think you alluded to that earlier. Every county and city in the country has different rules related to business license but they’re easy to find. You could Google that real quick and find out what is required.
STEVEN: We’re here in San Diego. I can go to sandiego.gov, in your particular city there’s probably a .gov as well, web address and look in there under getting started with a business or how do I start a business in the city of San Diego and there are complete instructions on how to do that. Some of them are a little janky. They don’t explain things that well and that may be why you want to work with someone who can help you do that and get it set up the right way to start with. It’s not that much of a cost to make sure that you’re protected on having the right way to get things set up.
Organize Your Freelance Business
That takes us to this third area. How are we doing on time? Okay, a couple more minutes. So, this is under getting organized. We’ll wrap up with this third area. We talked a little bit about business licenses. Rosita as well as Suad had asked the same sort of question, “If it’s just me, no employees, do I need to get a business license?” We just covered that and that is basically look at your city.
MARK: It depends.
STEVEN: Yes, it depends. If you’re going to get employees you certainly need some sort of…
MARK: Well, if you need employees you still might not have to have a business license but it comes back to whatever the county or city requires. If you’re going to have employees you have to get an EIN, or tax ID number, which is the same thing. You have to go to your state and file with your employment department there and make sure you get an ID number for that because you have to file payroll taxes both to your state and to the IRS. It’s an additional layer of complication but it’s not that… You just make sure you’re dealing with somebody who can walk you through that process.
STEVEN: Let’s jump into multiple sources of income. These are basically the same question. We had several people ask about this. Let me explain it here and get your opinion on this. Barbie, Carl, Ian, and several other folks had asked this. “I teach but I also receive a significant portion of my income from performing.” Or if you think about coaching, I teach but I also play on a certain team that earns income. “Do I need special preparation since I have two sources of income? Can I combine the income or do I have to have two different businesses because I have two different sorts of income?” What do you think about that?
MARK: I don’t think you have to as long as the type of income is similar. What I mean by that, you can’t combine rental income with teaching income. Those are two different types of income. Rental income is taxed differently than what we call earned income. I don’t want to get too complicated by that’s earned income. Rental income is passive income so they are treated differently for tax purposes.
Anything that you are earning that is not a W-2 you can put on the same form. Anything you get a 1099 for, you could put that on your Schedule C and you could file one Schedule C. You can say that you do different things. For example, we’re a CPA firm. We do audit work, we do tax work, we do consulting work, we do accounting work. We don’t file different entities for each one of those services. They’re all somewhat related. If you’re teaching and you are tutoring and you are doing private consulting related to your particular business then I don’t see why you would have to have multiple Schedule Cs for that.
STEVEN: So using that example out there, I’ll just use me as a proxy for this. I could have Steven Cox, professional and that’s the name of my business of which I teach and I derive a certain amount of income for that. I also consult with a company along the same lines of whatever I’m teaching. That could be considered income and I go and I play gigs at night. All of that has to do with my professionalism, my artistry as a musician or as a tutor or whatever the case is. So instead of having to set up all of these different entities and separate all of this, you can call that all a part of one business and all of that just simplifies your life times x.
MARK: Right. So if you get ten 1099s for that – you’re getting 1099s from all these various entities that you are providing these services for – as long as the total amount of gross income, that means the sum of all of those 1099s and any income that you don’t get on a 1099, as long as that number is larger than all the 1099s you get on your Schedule C sole proprietor tax return, then you’re fine. If it’s less then you’re going to get a letter from the IRS asking why you unreported income.
STEVEN: Right, so make sure you report that income first and foremost. If you get a 1099 it goes on your taxes. No question about it. That’s the way it should work.
MARK: Right, and even if you don’t get a 1099 you’re supposed to report the income.
STEVEN: Yes. That is the law. We’re almost out of time. Estimated taxes – we have some questions regarding estimated taxes. Let me find the questions here. I’ll read two or three of them and then we can just have a conversation.
I read something about estimated tax payments for independent contractors. Is it necessary? How do I estimate it? Should I set aside income so I have money to pay? How do I set things up so I’m not scrambling to get enough money together to pay for self-employment taxes? All of this is about organizing correctly. What about estimated taxes? What do you find? Let’s say this average is kind of around the $50,000 mark for income. What do you suggest there?
MARK: Net income $50,000? That’s what you get?
STEVEN: Let’s say gross. Gross is the amount that comes in your front door but you have all of these deductions so it’s going to be a lot less than that with respect to what you pay. What would you recommend with estimated taxes?
MARK: The answer is it depends really on the individual. Estimated taxes are related to your complete tax situation. That means if you’re married you’re going to file a joint tax return. All of your income gets tallied up and whatever you’re left with, whatever you either owe or you get a refund back, depending upon how much money you’ve paid in during the year.
That’s really what we’re talking about here is how much money have you paid in the year to cover what your tax liability is when you actually go to file your tax return. In our tax system, they have a system called pay as you go. The IRS wants you to pay taxes as you earn it during the year. They don’t want you to owe a bunch of money at the end of the year because they have learned that they don’t get it all the time.
So what they will do is if you do owe too much money they will penalize you and they will add interest to the money that you owe. So if you are supposed to make estimate tax payments on a quarterly basis. The quarterly due dates are not completely intuitive. The first quarter estimates, for example, are due April 15 but the second quarter is due June 15, before the quarter is over. Then the third quarter is due September 15 before the quarter is over but then the fourth quarter isn’t due until January of the following year.
STEVEN: The IRS is so clear. It’s wonderful, isn’t it?
MARK: At least they’re consistently inconsistent. The answer to the question is yes, you should be making estimated payment to avoid penalties. Depending upon how much tax liability you may owe at the end of the year… I have clients that say, “I don’t care. I’m not going to give them any of my money until my returns are filed and I’m just going to deal with the interest and penalties,” because it’s not enough money for them to have to worry about it. That’s an okay position. Just know you’re going to pay a little bit extra.
If you want to get to the right number, then you need to be either good at filing tax returns and being able to estimate where you’re going to end up during the year or you need to hire a tax professional to do those estimates for you so you can know how much you’re supposed to pay in. If you pay in at least as much as you owed the prior year, if your total taxes, not owed, if your total tax liability was $5,000 for 2014 and you’ve paid in at least $5,000 for 2015 then you’ll be fine on having no penalties as long you paid it throughout the year.
It’s what I call a quick question that isn’t always a quick answer because we have to really know everybody’s individual situation.
STEVEN: It sounds like the correct answer for that as well is this is where it really pays to work with someone year after year on your particular tax situation.
MARK: Yes, because then they really know.
STEVEN: It could be that you shouldn’t be paying any quarterly taxes. It depends on your personal situation.
MARK: Right. So back to netting $20,000. That may or may not turn into a major tax liability but if all of that… If you’ve already deducted all of your itemized deductions and all of the income from your Schedule C is taxable, you’re going to pay 15.3% tax on that money plus 15% ordinary income tax plus whatever your state income taxes are. That’s 30-40% of that money if that’s the only thing we’re talking about. It depends on what their overall situation is.
STEVEN: Cool. We have time for one last question. It’s coming from Nicolette as well as Jessie. I hope I pronounced your name right. Do you recommend going to an accountant versus doing taxes myself and what do you feel about places like H&R Block versus just a real… I don’t know if that’s the right words – a real accountant. Not saying they’re not. If there’s anyone from H&R Block out there don’t hate on H&R Block. What do you think about that? I have my personal opinion which I’ll give after yours but please, you first.
MARK: I think oftentimes people think they’re saving money by doing their own tax returns and they are upfront. If you have a simple tax return, simple 1040, a W-2 and that’s about it then you probably don’t need a tax professional. But if you’re self-employed, you have rental properties, you own a home, you have multiple places you work, it gets a lot more complicated.
More times than not you’re going to make a mistake on your tax return, either for your benefit or to your detriment. It’s hard. That’s really where people get audited more times than not is when they take really large deductions.
I’m actually embarrassed to tell you. I’ll tell you a story real quick. I won’t say his name but…
STEVEN: This guy I know.
MARK: A family member of mine does his own tax return because he doesn’t want to bother me with it. Took way too many deductions and creative a massive red flag and of course he’s being audited. So, yes, he paid less in taxes than he would have with us but now he has a huge issue…
STEVEN: The pain.
MARK: The pain and suffering. The other way, it goes the other way oftentimes too. People are too worried about what they can deduct. They don’t know really where we’re taking a position. Sometimes you have to take a position and you really need a professional to help you know where the line should be drawn in the sand with that. I think the difference between a CPA firm… I should back up.
You have H&R Block like somebody asked about. The people who can do tax returns are people with what they call a CTEC certification, an enrolled agent, a CPA, or an attorney. All of those people have different continuing education or education requirements. So it depends on what you really need. H&R Block is a fine company. They are large and they’re huge and they do a lot of tax returns. Their education requirements are much less than mine. For example, I had to get a degree. I have to do 40 hours of continuing education every year and we really are advocates. We are licensed by the AICPA.
CTEC and those others are licensed by the IRS so they have a different regulatory body they answer to than we do. We are focused on being an advocate for our clients and we’re not… The IRS, I wouldn’t say they are adversary but they are certainly not who we serve. We serve our clients so it’s a little bit of a different relationship. But H&R Block is a fine company.
STEVEN: I think the key personally for me, I’ve used an accountant now for 12 years, 13 years, the same one and there is a rhythm that you get in when you use the same person who is good over and over who understands your situation and then can advise you near the end of the year, as the year is going on, if you’re about to buy a home, you’re about to buy a new car, how do I take these deductions. What I have found is that I have saved so much money in taxes that I would have paid by working with a professional than if I wouldn’t. So I personally just from my two cents, I’d personally recommend it.
It’s the same if you think about it for all of our musician instructors out there. It’s the same as someone watching a video on YouTube versus hiring you. You know what I’m saying? It’s like you could probably get by with YouTube, maybe learn a little bit, and kind of do your own thing but why do that when you’ve got a professional sitting here who can really help you out. I think that’s how I would personally view it is if you’re serious about your business and serious about making teaching your career that it’s worthwhile to find a reasonably priced, good accountant, CPA firm who can grow with you as you continue to grow.
MARK: It really comes down to the relationship you have like you’re saying. It’s important to have that if you’re going to be self-employed for any extended period of time. You need somebody. Even if you’re goal is to buy a house maybe you shouldn’t be so aggressive on your deductions in a particular year. Those are questions and answers you need to have with your CPA.
STEVEN: Great. Thank you. We are out of time. Maria is giving me the old cut it thing. We’re out of time. I wanted to thank Mark for being with us today.
MARK: Happy to be here. It was fun.
STEVEN: Mark, if folks wanted to get in touch with you or your firm, I’m sure you have a website?
MARK: We do.
STEVEN: What is your website address?
MARK: We are CWDL CPAs.
MARK: Yes. You can go there and find us. You want my phone number?
STEVEN: Sure. Absolutely.
MARK: You can tell I’m a huge sales guy. I’m a CPA. It’s 858-565-2700.
STEVEN: That’s if you’re in San Diego or even in California. I’m sure you do most of your work there.
STEVEN: There are other great CPAs if you’re on the east coast. I’m sure there’s folks in your local area that also have similar certifications but you want someone that’s good at doing taxes if you decide to reach out for help.
MARK: Yes. Just make sure that you’re doing your homework and that you’re taking deductions that you’re entitled to.
STEVEN: Thank you again for your time. We really hope that this has been a tremendous value to you. We wanted to really make sure that you a) could take all the deductions that you need, b) know how to organize properly, and c) answer the questions on how to get your either sole proprietorship or corporation set up. Thanks again. I hope you have a wonderful awesome Christmas season, holiday season, coming up and we will see you the next time we see you. Thanks. Take care. We’ll see you. Bye bye.