Tax Tips for the Self Employed


This is taken from the IRS website and provides answers to questions that I'm asked on a routine basis. My only addition would be that in #3, many of you may be eligible to file a Schedule F for farmers, rather than a Schedule C.

IRS Tax Tip 2012-16, January 25, 2012

There are many benefits that come from being your own boss. If you work for yourself, as an independent contractor, or you carry on a trade or business as a sole proprietor, you are generally considered to be self-employed.

Here are six key points the IRS would like you to know about self-employment and self- employment taxes:

1.Self-employment can include work in addition to your regular full-time business activities, such as part-time work you do at home or in addition to your regular job.

2.If you are self-employed you generally have to pay self-employment tax as well as income tax. Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. You figure self-employment tax using a Form 1040 Schedule SE. Also, you can deduct half of your self-employment tax in figuring your adjusted gross income.

3.You file an IRS Schedule C, Profit or Loss from Business, or C-EZ, Net Profit from Business, with your Form 1040.

4.If you are self-employed you may have to make estimated tax payments. This applies even if you also have a full-time or part-time job and your employer withholds taxes from your wages. Estimated tax is the method used to pay tax on income that is not subject to withholding. If you fail to make quarterly payments you may be penalized for underpayment at the end of the tax year.

5.You can deduct the costs of running your business. These costs are known as business expenses. These are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year.

6.To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.

Year End Checklist

1. Get together all of your receipts. Organize them by type of expense - feed and grain, farrier, etc. Compare them against your checking and credit card accounts to make sure that you haven't missed any deductible expenses.
2. Balance your checkbook. There might be checks or deposits that cleared the bank that you have omitted from your checkbook.
3. Are there any customers that owe you money at year end? How old are the balances? Are they still collectible? Contact the customer and remind them of any overdue balances. Negotiate for partial or periodic payments if possible.
4. If you purchased anything using a loan, be sure to include the basic loan information in the documents you give to your tax preparer.
5. Are there any bills that you owe that aren't recorded?
6. When you have your preliminary financials ready, compare them to 2010 for reasonableness. Do they make sense, knowing what you know about your business?
7. Have there been any major changes to your life in 2011 - gotten married, had a baby, lost a job? Will there be any major changes for you in 2012? Be sure to share that information with your tax preparer.
8. Make a list now of topics that you want to discuss when you speak with your tax preparer - retirement planning, funds for your child's education, paying off your mortgage, etc.

Preparing your return is something you have to have done every year. Use it as an opportunity to know and grow your business. During the year, you are "in the trenches" day after day. But getting ready for your tax return gives you a chance to step back and give your business a more objective, global examination. Maybe you'll need to make changes, maybe things are great as is. But by taking a long, hard look, you'll know.

Are you a Material Girl/Guy?

I'm never sure when I listen to Madonna sing "Material Girl" if she thinks that being a material girl is a good thing or a bad one. But being a material girl/guy in relation to your business is definitely a good thing when you are dealing with IRS matters.
If you own a business and that business incurs a loss, the amount of the loss that is deductible for tax purposes may be limited by several factors. One factor is whether you materially participate in the business. Material participation only becomes an issue if your business is organized as a pass-through type entity (sole proprietorship, partnership, S Corporation or LLC for tax purposes treated as a sole proprietorship or partnership).

Before I discuss what factors the IRS uses to determine material participation, a little necessary background info. about pass-through entities. In pass-through entities, the profit or loss is calculated for the business as an entity and the information is submitted to the IRS but no tax is due at the entity level. The profit or loss is "passed through" to the owner(s) and included on their personal return. If a loss is passed through, it can generally be applied against other types of income such as wages, interest and dividends. That makes a loss valuable to the taxpayer because it can decrease the total amount of tax due on the return. However, if an individual does not materially participate in her business, losses are treated as "passive" losses, which mean they generally are only deductible against passive income such as rent, royalties or other businesses with passive income. Not so useful now, right?

What factors does the IRS use to determine material participation? Generally, for an individual to be considered to materially participate in a business, she must be involved in its operation on a "regular, continuous and substantial basis". More specifically, there are seven tests that the IRS uses to determine material participation and a business owner must satisfy at least ONE of the tests:


* 500 Hours: individual participates in the business for more than 500 hours during the tax year.
* Substantially All of the Work: the individual's participation constitutes substantially all of the participation in the business compared to all individuals involved in the business.
* More than Anyone Else: the individual participates in the business for more than 100 hours during the tax year and that time is not less than any other individuals involved in the business.
* Significant Participation Activity: The activity is a "significant participation activity" (SPA) and the sum of SPAs in which the individual works 100-500 hours per year exceeds 500 hours for the year.
* 5 Out of 10 Years: The individual materially participated in the activity for any five tax years during the prior ten tax years.
* Personal Service Business: If the individual materially participated in the activity for any three tax years preceding the current tax year and the activity is a personal service activity, the loss will be treated as non-passive. A personal service business is one in which capital is not a material income-producing factor. Examples of PSBs are accountants, lawyers and doctors and in the equine world, free-lance instructors and equine chiropractors.
* Facts and Circumstances: The facts and circumstances test may apply if none of the other tests are met. This test does not apply unless the individual worked more than 100 hours a year. Also, the taxpayer's time spent managing will not count if:o A paid manager participates in the business, ando Any person spent more hours than the taxpayer managing the activity.


Material participation is determined on an annual basis so you may be considered to materially participate in your business one year and not another.


Material participation is only one factor that can limit the amount of loss available to the business owner. Other factors include limitations due to basis, amounts at risk and hobby loss rules. So be sure to consult with a qualified tax advisor to understand all of the factors affecting your situation.

The first year that I prepare a tax return for a client, it isn't unusual for me to get a lot of receipts for deductions for clothing related to their job or business. Many times, I have to be the bearer of the bad news that the cost of most of the clothing is not tax deductible. The types of clothing that are tax deductible are very limited and I use what I call the "Department Store Rules" as general guidelines to determine what is and is not deductible. My "Department Store Rules" are 1.) Can you buy something similar to your potentially deductible clothing item in a department store? 2.) Would most people feel comfortable wearing this item of clothing into a department store? If the answer to either question is "Yes", chances are that the cost of the clothing is NOT deductible. So on the "NOT deductible list would be items such as:

Sports bras
Muck boots
Favorite polar fleece jacket even if that jacket is manufactured only by an equestrian clothier
Extra warm coat you wear when you are giving lessons, teaching a clinic, judging, etc.



You get the idea.



So what is deductible?



Protective/Safety Clothing: hard hats, riding boots, chaps, riding gloves, protective vests and any other type of protective clothing not suitable for everyday wear.








Show Clothing: breeches, top hat, hunt jacket, etc IF the showing is a business expense (e.g. you are showing your clients' horses, sale horses, etc) AND the item of clothing is not suitable for everyday wear (e.g. your lucky show socks, the T shirt you wear under your show coat ...).



Something you can do to expand this rather narrow window of what is deductible very slightly is to have some of your regular business-use clothes embroidered with your logo or otherwise use them as a marketing device. For a trainer who frequently coaches at horse shows, you could have your baseball cap and jacket embroidered with your business logo and the cost of the clothing and the embroidery would normally be deductible. Don't go over the top on this idea and have everything in your closet embroidered or the IRS could disallow all of the deductions. Weigh the cost of the tax savings you gain by getting the deduction and the possible marketing benefits against the cost of the embroidering to see if the idea works for you.





Remember that for any expense to be deductible it must be a business-related expense, ordinary (common and accepted in your type of business), necessary (helpful and appropriate to your business) and you must have documentation (receipts) that you actually incurred the expense.








So on your next trip to the tack shop, remember my "Department Store" Rules and you'll know how much of your purchase should be tax deductible.

It's all about you!

You can have the best employees in the world but the reason most clients will start to do business and stay with your business is because of you. This business was your brainchild, is your heart and soul, you who makes or loses money...no one should be more invested in your business than you. But sometimes, it's not just working hard. It's working smart.



For example, you could try to save your business some extra dollars by doing all of the office work yourself. But if you are out in the barn, instead of in the office, you can connect with clients and employees. Checking in with clients may result in additional lessons, training or showing and can certainly result in more revenue for your business than whatever you'll save working in the office. You don't have to hold big parties or give great Christmas gifts. It can be as easy as taking a couple of photos of great moments in a lesson and e-mailing them to the student (or student's parents) later on.



Clients want to be treated "professionally". By dressing appropriately and focusing on your clients' needs, you show that you value the time and money that they are spending on your business.



You can also create goodwill by being approachable when you are away from home. Potential clients frequent the rail to watch how you interact with your students and horses in training. But be sure that potential clients can identify who you are by jackets, saddle pads, etc with logos that are easily readable from a distance. Check with your showing association to see what is allowed.



Try to find high exposure opportunities to which you can donate your time - clinics to benefit a cause, speaking at your breed or show association, etc. The return on your time will be rewarding to your business in terms of good PR and eventually, in dollars of revenue as well.



In the end, EVERY business decision you make (and remember, not making a decision is really making a decision not to act) effects the bottom line of your business. Represent your business well and work smart and you'll get monetary as well as personal satisfaction from your career.

Even the most diligent employees won't watch over your money as carefully as you do. So if you aren't responsible for all of the purchasing decisions at your farm, you need to create incentives for employees to make cost-conscious purchases. The easiest way to do this is to set an annual budget for each type of recurring purchase - feed and grain, supplies, maintenance, etc. The budget should be attainable and realistic and there should be some reward to the person responsible for purchases (e.g. barn manager) for coming in at or under budget. Suggest possible strategies for reaching the budget goals - purchasing in bulk, buying generic rather than name brands, etc. Require that any major changes be subject to your review before making the change. You want to save money but you don't want to replace a satisfactory product with an inferior one.

Another way employees can help save you money is by following established safety procedures. Accidents or injuries due to an employee neglecting to follow established safety rules will be reflected in increased rates for your workers compensation and general liability insurance. If your worker is injured, it will cost you money in the form of additional labor costs, possible reimbursement of medical costs and even potential lawsuits.

Is it possible to utilize your workers to do some of non-income producing work that you currently do? If you could be producing income but are instead stuck behind a desk, that's a lost opportunity cost. For example, if you can find a suitable substitute, you can hand over responsibility for monthly invoicing of clients and start teaching more lessons yourself. Finding a suitable substitute may mean hiring a part-time bookkeeper at an hourly rate less than what you'll be making teaching lessons. You'll be making more than you are spending for the bookkeeper and you'll be interacting with clients, where you belong.

Ask your employees for suggestions for cost-saving measures. They may notice poor quality or waste that is costing you money. They see a side to your business that you may not and can be a great source for ideas. Also, including your workers in the decision-making process is great for team-building and instilling a greater sense of responsibility.

Your employees can be a drain on your business or a resource for your business. It's up to you to create a work environment to benefit you both.

Equine Accounting: Looking for "People People"

When you look for an employee for your horse operation, you want someone who is good with horses, someone who can paste worm the most difficult horse in the barn with one hand tied behind their back, clean five stalls in less than five minutes and other equally impossible tasks. A big part of your livelihood comes from horses so, of course you want to hire employees who are strong in those skills - "Horse People"

But horses are only half of the equation. Horses are owned by people, expenses incurred by horses (like hay, grain and shavings) are paid by people and some people can complain a lot more loudly than most horses if they aren't happy with the services provided. Yet most employers don't consider the skills that are required for good customer service when making a hiring decision - "People People" and not just "Horse People".

While it isn't likely that most of the job applicants for horse businesses have had extensive training in customer service, some may have had experiences that will serve as a good basis for developing awareness and consideration of customer needs. So don't just focus on how many barns the applicant has worked at in the past. Also ask about experiences working in retail or service industries, where customer service is key.

No matter what their experiences, you need to provide training so your employees KNOW how you want them to handle a situation. Role play scenarios and offer suggestions for responses. When a client mentions that she heard that her horse wasn't turned out today as promised, "I forgot" is not an appropriate response but "Let me find the barn manager/owner and I'm sure she can answer your question" might be one example of how you'd like your employees to address the situation.

Spend some time in your barn and listen with the ears of a customer, not the owner. You might be surprised at what you hear - a barn manager berating an employee at full volume, a barn employee explaining to a customer why she hates working there, etc.

Good "People People" employees = satisfied customers who are eager to patronize your business and put money in your pocket. So invest in your employees by providing them with the customer service skills they need to help make your business a success.

Visit my website www.blueribbonaccounting.com to learn more about equine businesses.