The solution to America’s tax problem: Indies

Can you believe it?! The federal government’s deficits continue to pile up. The $9 billion-per-month war in Iraq is bleeding the revenues dry and Washington needs more money. Where will the money come from?

The answer has just been presented to us in a new report from the Government Accountability Office (GAO).

If it’s a relief to you that there is an office somewhere in Washington responsible for government accountability, you’ll be disappointed to learn that the accountability that the office has been checking on is not about the government but about indies. It seems to the accountability office that the indie – those millions of sole proprietors that the government suspects of hiding income – is the chief problem in American tax circles these days.

According to the accountability office at least 61% of sole proprietors underreported their business income in 2001 (the accountability office hasn’t accounted for the years beyond 2001 yet. Hmmmm …. ever wonder what would happen to you if you were four or five years behind in filing your tax return?) One bit of anecdotal backup tells of an Internal Revenue Service examiner who found $30,000 in net income that a sole proprietor had failed to report, which made a difference of $8,000 in taxes. Another indie who reported a $30,000 loss (it was a construction business) had actually netted, according to the IRS, $45,000 in taxable income.

This report, according to former IRS Commissioner Donald Alexander, is “very significant in these times when tax reductions have to be paid for by tax increases.” If that sounds confusing, it will be cleared up later in my post.

The report emerges at just the right moment for the Bush Administration, which is asking for a 5% increase in the IRS budget (to over $11 billion) to help bring in more money. More power to probe into the finances of indies will help to lower the tax gap of $290 billion that the IRS has estimated for the tax year of 2001.

The administration also seeks legislation that would require credit and debit card services to report all payments made to sole proprietors. That means if you accept payment for your services or products by Visa, Mastercard, or any of the other merchant accounts then the merchant account bank will sent out a form similar to a 1099-MISC stating how much you earned through their bank. I expect the merchant bank will charge you an additional 3% or 5% or 9% for providing that service to the government.

Sole proprietors represent less than 5% of all business receipts, and more than two thirds of them have gross receipts of under $25,000. Does that sound as if it’s the key to solving America’s tax revenue problems?

Of course indies should report all their income to the government, and the cheating ways of some indies has put all of us under suspicion.

But it appears that the administration is taking the easy way out by going after the most powerless and disorganized force in the U.S. economy.

That’s what the former IRS commissioner meant in his confusing comment: he was referring to tax reductions (for the powerful) being offset by tax increases (for the powerless).

We indies lack power because we don’t have organizations big enough to fight back effectively. So, learn the rules of the game. Play them right. Report all your income. Get your taxes as low as possible by deducting every business expense. For a complete guide of tax basics for indies on income, expenses and recordkeeping, check out my book Self-employed Tax Solutions.

Statistic sources for this post were from Sole Proprietors Face Tax Scrutiny, by Tom Herman in The Wall Street Journal and from the GAO report.

Want another opinion? Check out a post on the same GAO report by David Hendricks of the San Antonio Express-News, Self-employed Skirting Taxes.

If you want to know all the particulars of the GAO report, you can read it here: A Strategy for Reducing the Tax Gap Should Include Options For Addressing Sole Proprietor Noncompliance.

Minister's Travel Expenses

June --

I am an ordained, self-employed minister. I will be traveling out of town serving as a interim for a local church. I will be leaving my home and staying in a different town 110 miles away from Sunday to Thursday. Am I entitled to the per diem method for taxes and can I deduct the mileage?

Thanks for your help.
Ed from Knoxville, TN


Ed --

I assume you work from home and that this assignment is temporary. The costs of getting there and back [travel expenses] are deductible. You may also use the per diem for meals and incidentals [not lodging] . You may use only actual costs for lodging.

There is more info on travel expenses at this link.

-- June

ALERT! Real Estate Seminars

Hi June..

Stumbled into your site. Great info, but could not locate a question similar to the one I have. I had spent a fortune last year (2006) on real-estate training. I heard from those gurus the line that this is "tax-deductible check with your accountant."

I hear different approaches to deducting those expenses.

As a background, I work a w-2 job in the computer industry. I am developing myself into a real-estate consultant and investor to be done on a part time basis. My wife is also joining me and is preparing to get her real-estate agent license.

I have started an LLC this year. It is Nevada-based. I will be adding my wife to the LLC soon. I have one rental property in Alabama bought in 2007 and am a resident of California.

Back to the deduction of all those expenses -- the approaches that have been suggested are:

A. Use all those education (including travel etc) expenses and add it as a basis for acquiring the rental property and therefore use it as part of the depreciation calculation.

B. The other suggestion is to "loan" the said amount to the LLC I have, since I will be serving the LLC with all that expertise acquired through the education.

C. The other one I found was to take $5K in the 1st year as business start-up expenses and keep the rest for subsequent years.

What are your thoughts and suggestions?

Thanks - Ravi


Hello Ravi,

I am so glad that you stumbled onto my site. I hope it keeps you from some serious stumbles in the future!

Were those "different approaches to deducting ...expenses" that you list presented to you by the butcher, the baker, and the candlestick maker? Certainly not by your tax professional -- right?

You cannot get sound advice unless you

A. Seek out competent professionals.

B. Present your background fully.

C. Ask well thought-out questions.

I would not advise on which real estate to buy because I don't have the expertise. And I don't expect accurate tax advice from realtors or guys selling real estate seminars. My readers should not spend money on such seminars unless they check out the credentials and expertise of the presenters before taking the courses. Note I said, BEFORE.

Based on the info as you present it, it appears that all the advice you got is wrong.

You say you are an LLC but you didn't say which kind of tax entity. Check out my posts about LLCs linked here? If you are a sole proprietorship LLC you cannot loan money to yourself.

You say that you are developing yourself into a real-estate consultant and investor. There are different tax treatments depending on your business relationship to real estate, such as, are you a ...
... Real estate investor
... Rental property owner
... Rental property owner as a real estate professional
... Rental property owner providing services.

Read this post Real Estate Sales & Self-employment Tax to understand the differences.

You said you are "developing" a business, not that you are a business. And so, contrary to what the seminar presenters told you, you cannot deduct as a business expense any education costs that prepare you for a new profession. However, there are various educational tax credits available for all taxpayers.

Nor are the expenses considered start-up costs. I suggest you read More about START-UP COSTS: The expense of checking out a new business .

To any of you considering a business in real estate -- or any other indie venture -- I suggest you start by learning the basics about indie taxes in my book, Self-employed Tax Solutions. It's your first step toward developing an indie business mindset.

Indie Business Mindset: Learn the Basics

I get many questions from blog and website visitors. I choose to post the questions that provide information to a wide range of independent professionals. And I post others that offer guidance to all indies. To acquire an indie business mindset must be a goal of all self-employeds.

In my book and seminars I explain specific ways to take a business approach to your indie venture. In my posts I give you unique questions from my indie readers.Their questions are unique, but, alas, their situations are not. They all need to work on developing a stronger indie business mindset.

Greg, from Douglasville, Georgia, sent me the email below. I embedded my response to him. Greg's situation is another example of a self-employed person not thinking like a business -- not looking at what he does as a professional endeavor. See if you think the same as I do.


Hi June -

I filed an extension, so I have more time...brief background, I had $12,000 total income for 2006.
What kind of income? From employment, self-employment, investments, rental property?

If I go the 1040EZ route again I will have to pay $250 federal & $175 state.
You can't use a 1040-EZ if you are self-employed.

My question is, I had a $7,000 medical bill this year & I have about $3,300 in mortgage deductions. Medical and mortgage interest are not business expenses.

Is it worth the effort to file an extended 1040 with both Fed & state just to save the $425?
Whether you invest your time to save your money is a question only you can answer. The first question is: What is your time worth?

Also must mention if I do this, I will have to pay a tax preparer most likely.
I highly recommend that self-employeds not prepare their own tax returns. Do your homework and then use a tax preparer experienced with indies.

In addition to having such a bad year when I have unusually high deductions I hate to pay taxes.

I think in 1947 there was a case reported of a man named Homer Slade who said he enjoyed paying taxes. This is the only known case on record.

Your advice is appreciated. Thank you, GT
You are most welcome, Greg. Asking questions points you in the right direction. Know that whether you make $1,200, $12,000, $120,000, $1,200,000 a year, you are a business. A business is run by certain rules and my blog and website are a good place to start learning the basics. Here's some links on both:
I am a Business
Is it a deductible business expense?
Help! I am self-employed. NOW what do I do?

Multi-faceted Sole Proprietorship

Dear June,

Thanks for the great site! I am a teacher/tutor/editor/writer.

This year, I have taught part-time at a university and worked as a temp. I want to set up a tutoring business. I was advised that I could cluster all my writing-tutoring-etc. earnings together by starting a "sole proprietorship" in my own name. 1. Is this true? 2. If so, wouldn't it be better to register it officially? (one of your pages starts by saying you needn't, and then goes on to say there are many situations where you do).

I like the "one name" idea so I could put the income streams together, though I prefer a trade name for privacy reasons.

However, given my situation, what would you suggest is the best way to go forward.

Thanks for your help!
Anna from California


Hello Anna,

Glad you like my site. Thanks for letting me know.

Yes, all elements of your business are related and so you may be one sole proprietorship. [Of course, this does not include any income as an employee.]

I don't know what you mean "register officially." Other legal matters you must take care of depend on on local law and state sales tax. However, those requirements have no bearing on your being a sole proprietorship.

A trade name -- DBA, doing Business As -- does not mean that you cannot be a sole proprietorship. See the "business name" category on the left.

All indications are that sole proprietorship is all you need. If you haven't already, be sure to read , I am a Business on my website.

Converting from Personal Use to Business Use

Maureen, from Las Vegas, Nevada asked:
First, I love your Self-Employed Tax Solution book! ... Can I take a deduction for the furniture and office equipment in my home office? I bought the furniture about 14 months before becoming an Indie and I do have the receipt for it. My fax machine, printer and laptop are quite a bit older. I don't have receipts for them or know what I originally paid so I don't their estimated current value.

The short answer is yes you may deduct them at whatever you could sell them for at a thrift or second hand shop as long as that amount is less than what you paid for the item. If the current value is more than you paid, then you can deduct your cost.

Caitlin Caterer and Eddie Electronic are new to self-employment. Here's a more detailed explanation of their equipment and supplies conversion, on my website at How to convert equipment and supplies from personal use to business use. The column is
excerpted from my book, Self-employed Tax Solutions .

Indie business Mindset: Success starts with homework

June,

My business is manufacturing of pneumatic cylinders since 2005.

If I had a refund for the tax year of 2005 and I owe for the tax year 2006, why do I have to pay an estimated tax now for tax year 2007?

Rosann


Rosann,

Refund or owe is not a determining factor in whether or not estimated tax payments are required. Payments are determined by your entire tax picture. For an explanation, take a look at Estimated Taxes posted earlier.

If I may, I am going to use your question as an example for other blog visitors. My goal for my blog and website and all my other writing and speaking is to get as much accurate, clear, simple information to as many indies as possible.

I also work at teaching indies how to get information. Many people who have read my book on tax basics send me beyond-the-basics type questions. Or people have unique situations like those of a cruise ship entertainer who lives on the ship, or a graphic designer who signed a really bad work-for-hire contract. I am still doing research on several of these kinds of questions received recently.

But with a lot of questions that I get it's obvious that no research effort has been done. A smart question goes something like this: "I have read your 5 or 6 posts on estimated taxes and still have the following question ..." [Categories are on the left. There's also ARCHIVES on my website.]

Do your homework, get some background on your question topic. If you know nothing, how will you know that my answer or anyone else's is correct?

My husband was an investigative reporter for a long time and he always did his homework. He told me that only if you really knew the background of the person your were about to interview would you be able to tell whether his answers had the ring of truth. Often he'd start with a question to which he already knew the answer.

Remember, you are a professional. You must have an indie business mindset in order to be successful.

-- June

Help! I am self-employed. NOW what do I do?

June,


I recently began working for the US Dept of Commerce on a contract basis, so I have no taxes withheld and receive no benefits. I've never been a contractor before, and thus never had to pay my own taxes, so I'm wondering if there are any self-help resources out there for me, preferably any software that will do it for me??

Please help me!!
Andrew from Utah


Hello Andrew,

A word processing program cannot make you a writer. A calculator can't make you a mathematician. A software program cannot be your bookkeeper or accountant.

Switching from employee to self-employed status is daunting because nobody tells you where to start to get information -- and you need a lot of information.
As a new indie, the areas you need to learn about break down into:
*** Recordkeeping for income
*** What are dedcutible business expenses
*** Recordkeeping for expenses
*** What taxes do you pay
*** How do you pay taxes

I recommend you start by reading a short column on my website, such as: Is it a deductible business expense? and Estimated Taxes, a post on this blog.

If you like what you read there, I encourage you to buy a copy of my book, Self-employed Tax Solutions, featured in BusinessWeek. The book answers many of the most common self-employed questions in the same easy-to-understand style you'll find in my columns.

Solutions will give you a basic understanding of what it means to be self-employed. This understanding will give you the confidence to know which step to take next.

I wish you much success.

Best regards,
June Walker