|Volume 1: No. 37|
If you don't incorporate, you're running a sole proprietorship. (If you've ever run a garage sale or hired someone to mow your lawn, you've done business as a sole proprietor.) It's not a "business," though, unless you're in it to make money (at more than a craft/hobby level). The government starts to take an interest when you claim business deductions on your tax statement.
There haven't been many tax changes this year, and there aren't many options for people making less than $100K. Be sure that you have Social Security numbers for all dependents over one year old. Deductions are not allowed for personal interest charges (auto loans, credit cards, etc.), but you don't have to pay taxes on employer-paid fringe benefits (professional dues, child care). If you buy business equipment, the first $10K can be written off without depreciation. [Rick Maxey, Self-Employed America, 11/91.] (Are textbooks acquired for review treated as income?)
If you have a home office, you'll need the new Form 8829, Expenses for Business Use of Your Home. You should take the deduction if you have a separate area set aside for business use. The new form will help you prorate mortgage interest, real estate taxes, home maintenance, insurance, utilities, and depreciation or rent. If you are intending to sell your home, it's best to convert the office to personal use (and give up the home-office deduction) before the sale. (Take photographs.) Either that or stop depreciating the house, since it's depreciation of the office space that triggers capital gains "recapture." [Linda Stern, Home-Office Computing, 12/91.]
If you're self-employed and don't have a Keogh plan, you have until the end of the year to establish one. You can put away as much as 20% of your income (up to $30K per year), and you don't have to decide the amount until 5/15 each year. Taxes are deferred until you are 59.5, but there's a 10% penalty for early withdrawal. [Mike Espindle and Steve Nelson, Home-Office Computing, 12/91.]
If you travel for business, you can deduct transportation, meals and lodging, laundry, telephone charges, and tips, plus 80% of business meal/entertainment expense if you have documentation. If your trip is only partly business, keep a daily log and all business receipts. You can't deduct expenses for personal companions, but you get the full cost of a room or rental car if there was no cheaper rate for sole use. Keep tax records for at least three years. The IRS won't accept microfilm or other copies unless they comply with IRS regulations. [Milton Zall, Self-Employed America, 11/91.]
There are several approaches to accounting and business structure, and the government lets you decide. (Once you've studied your industry, the choice may be obvious. If you fail to choose anything else, you're running a cash business as a sole proprietor.) The IRS tries not to interfere with commerce; it just wants its share. Documentation it requires is typically generated by any well-run business, independent of tax concerns. (Sometimes the IRS is unreasonable, like asking for receipts from library copy machines. Sometimes they're sticklers for minor details, like disallowing a home office deduction if you've stored your personal tax records in your office file cabinet. I'll pass along any other gotchas I hear about.)
My biggest headache so far has been paying estimated tax. I had no way of knowing my income until the end of the year, so I risk IRS penalties of about 9% per year if I happened to pay less than 25% of the total in any quarter. Many consultants are in a similar bind, especially during the first year. You won't be penalized if you pay 100% of your previous year's tax level, but that's unrealistic if you're taking a big drop in income. There is a form for requesting an exception, but there's an easier escape if you also have a salaried job. Just file a new Form W-4 directing your employer to withhold any required amount in the fourth quarter. All withholding is treated as if paid in four equal installments, so it lets you retroactively add to your previous estimated tax payments. [Irving L. Blackman, EE Times, 6/17.]