EINs and Pensions

Hi June,

Thanks for your website. It gives lot of information for starters like me.

I just started working as indie software consultant. I wanted to open a solo 401k also. I read in your blog like if I want to contribute to solo 401k I need EIN number. If I apply for EIN number, I have to use that EIN number for my clients. Is that correct?

and also Do I have to open a business account with that EIN number or my personal account should be fine?

Thanks
Mani
Tallahassee, FL


Dear Mani,

EIN stands for Employer Identification Number. Here's a couple of my posts on EIN-employer identification # (2)

When you establish a 401k and certain other kinds of self-employed pensions you must get an EIN for the pension. That's because the pension is an entity -- something that is separate from you -- and it must have its own identifying number.

For some pension plans, once assets exceed $250,000 a tax return for the pension must be filed. It is Form 5500 or Form 5500-EZ. You, the indie, must then also have your own EIN because it is required on the Form 5500.

Keep in mind this does not mean that you have two EINs. Your pension has an EIN and you have an EIN.

You do not have to open a checking account with your EIN. You may use your personal account as long as you are not operating as an LLC.

I don't know what you mean by "use that EIN number for my clients."

-- June

Supplies or Inventory

Dear June:

Each year at tax time we have difficulty choosing a category for products purchased for my wife's hair salon. She is an INDIE, a cosmetologist who leases her own shop. We try to put things in the categories listed in your book, but are a little confused about colors, shampoo,foils etc. that are used on clients directly, products purchased for retail and then supplies like cookies, flowers, decorations for the shop etc.

We keep more detailed records for our own purposes to tract individual client expenses, but for tax purposes we wonder what we can lump together.

Thanks for Your help,
William for Joyce


Dear William,

You may group together the supplies that are used directly on clients as well as cookies, flowers, etc. In other words, those things that you use, or use up.

Things that you sell are part of your inventory. You need to calculate the value of what you have on January 1. Add to that what you purchase during the year. Subtract from that amount the value of what you still have left to sell on December 31. That ending amount is the cost of what you sold for the year. It is called Cost Of Goods Sold ... COGS.

Best,
June

Working and Traveling in More Than One State

June --

IT Consultant. I started work on 1099 in Oct 2008 on a 6 month contract in CA.

As a 1099 I am subject to self employment tax for Social Security and Medicare. Does CA have any additional self employment taxes to be paid?

If I travel to CA from TX on Sunday evening around 6pm and reach at 10pm, can I claim the full per diem amount for lodging and meals for that day or can I claim the per diem amount only on the days I work in CA?

Thank you
Bill
Dallas, TX


Dear Bill,

California has no self-employment tax. You may be subject to CA income tax. Read my posts here taxes -- state / nonresident state (6)

Travel meal expenses are explained in my posts here expenses -- travel (17) and here expenses -- meals and entertainment (12) and here .

-- June

EINs in Germany

June --

This is my question: During my first deployment in Iraq (2007-2008) I started selling books, DVD, and other items online in my free time as a hobby, after a couple of months I was receiving more than a few hundred dollars from Amazon, Ebay and other websites for my sales every two weeks, but the net income was very small ex: of $600 amazon deposit, only $50 would be real profit.

In order to get wholesale prices from the on line suppliers I got an EIN (Sole proprietorship, internet sales) from the IRS website and I kept selling. I really didn’t know a single thing about taxes, I didn’t keep any records or receipts of the books or dvds that I bought to resale online….. and I didn’t take it in consideration when I got the EIN from the IRS either, that the Army taxes office in Iraq couldn’t help me to file my taxes because of that EIN. So I didn’t file in 2008.

After we left Iraq I stopped selling because I don’t know what to do with this tax and EIN situation, I want to fix this and find out how to keep selling without getting in trouble.

I read in the IRS website that you can cancel the EIN number and retake at any time, do you think I should do that?

I ‘ve been trying to talk to someone that does taxes for Americans here in Germany but it’s not that easy.

I would like to hear what you would do if you were me.

Thanks a lot!!
steven


Dear Steven,

Do not get rid of your EIN. Having an EIN really doesn't make much of s difference in your situation.

Very simply: Keep on selling. Claim the income on your tax return and reduce it by your expenses. You must keep a record of expenses. On your tax return, your tax preparer will put your social security # and your EIN.

I have clients in Iraq and in Germany. I think you'll be able to find someone in Germany who can prepare your tax return for you. The preparer just needs to know the basics of filing a return for a self-employed person. Start by asking at the base then at the bank.

Best,
June

EINs and LLCs: Updated

Dear June,

Subject: "Payee" Name on Checks that are Written to Me?

I am an LLC operating as a sole proprietor in CO. The IRS does not require an EIN for my situation, so I have never used one. I have always instructed clients to write checks to my company name. Twice in the past year two clients received letters from the IRS. I haven't seen the letters, so I don't know the exact context, but the bottom-line is that my clients believed that if I wanted to continue to receive checks with my company as Payee, then I would have to provide them with an EIN.

For tax purposes, the IRS site clearly states that an EIN is not necessary for an LLC operating as a sole proprietorship.

For legal purposes, it's my understanding that you should always receive checks in your company name. So, how should a check be written?

Additional Information that May Be Relevant I like "clean" tracking, so I deposit the checks into a business account from which I also pay business expenses. When I want to pay myself, then I transfer funds from my business account to my personal account.

An EIN has seemed unnecessary, and it's never been a problem until this year. I loathe the idea of adding yet more numbers to my life. Is it feasible to continue avoiding an EIN

Thank you in advance for your guidance!

Rose

P.S. I diligently searched your book (which I bought many years ago, and often refer to and recommend to others). Trust me, I'm not just flattering you; your book is great and I wonder when you will write an update. I also searched your blog. I'm confident that either (a) my question is not already answered on your blog, or (b) I don't know the right key words to use when searching the book's index or searching your site.


Dear Rose,

This is an update to an earlier post on EINs.

The IRS now says that an LLC must have its own EIN.

If at all possible get a copy of the letters your clients received from the IRS. You said the the clients "believe" they can't pay you unless you have an EIN. Well ... what's that really mean?

You are also correct that in order to maintain the protection of the LLC checks should be made out to the LLC. Whatever name your LLC is registered as, is the name the checks should be made out to. Be sure you have that name on invoices and business cards so that clients will have a reference.

If your clients plan to send you a 1099 at year-end they will also need your address and your EIN.

Thank you. I am so pleased that you use my book as a reference. That is what it is meant for! By he way, all the basic information and how-to instruction in Self-employed Tax Solutions, although written several years ago, still applies for 2008 tax returns and so far for 2009 as well. Specific numbers may have changed but method has not. For instance, although the per mile rate for auto deduction changes every year, or even every half year, the all-important simple method I explain for keeping mileage records and the deductions for auto expense have not changed.

Best,
June

Need to feed the kids? Freelance AND work a job.

June,

I was reading your site. Great info!

I have a question. I've run my own business for almost four years. Due to the economic downturn, I've sent my resume out a few places. I have a job offer that I am considering with a firm...I don't really want to work for someone else, but the kids need to eat.

A few questions:

1. I intend to keep my other business going...I have a few commitments and can't shut it down completely. Will having most of my income W2 prevent me from taking normal business deductions?

2. The job offer is ok, but there are no benefits at all. I want to keep deducting my health insurance premiums through my business. They say there is some kind of group plan I can get into, but I'd have to pay 100% of the premiums...so they pay nothing. Can I still deduct health insurance premiums through my business?

Please advise,
Steven
Albuquerque, NM


Dear Steven,

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

Yes, you may work as an employee as well as freelance as a self-employed. Amount of income from each is not a factor as long as you are trying to make money as a self-employed. You may still deduct all your indie business expenses against your self-employed income even if it results in a loss. That loss would be deducted from your W-2 income.

You may not deduct health insurance premiums as a self-employed if your employer provides a group plan, even if you pay 100% of the premiums. If you continue to have insurance on your own as a self-employed you may deduct the premium cost as an adjustment to income on your tax return.

-- June

How are your plumber and the Treasury Secretary nominee alike?

In the Daily Beast, Tina Brown tells us we are in the Age of Gigonomics and that the “gig economy is no picnic.”

The economy is changing. So much so that it affects people even in the corridors of power. And because it affects them, it’s news.

The most stunning revelation to come out of the hearings on the Timothy Geithner nomination for Treasury Secretary is that nobody who is anybody understands self-employment tax. The columnists, pundits, and reporters – they’re all in the dark. Even Rep. Barney Frank, speaking on MSNBC, when referring to the self-employment tax, added, “whatever that is.” And he’s chairman of the House Finance Committee, which deals with financial matters like taxes. And even Mr. Geithner’s three accountants – whom we expect are members of the Masters of the Universe -- didn’t quite understand it. Wow. This is news!

Well, not really. It might be news that all these high-placed people have fuzzy math when it comes to self-employment tax but freelancers know that they have always struggled with it as a component in the rules and regulations of being self-employed.

Who are freelancers? Freelancer is just another way of saying self-employed, 1099 person, sub-contractor, independent professional, indie, solo. In IRS talk they are “independent contractors.” And they have always had a more difficult time in the American economy than have employees.What’s an employee? Somebody who earns wages, a salary, or has take-home pay, who usually gets benefits like vacation pay or child care benefits or a pension contributed to by the company.

Part-time or fulltime does not determine your work status. A part-timer is not a self-employed. A self-employed can work a 60 hour week.

Artist are indies. So, too, are most psychologists and plumbers and tech consultants. The guys who work for Blackwater are indies. Most politicians upon leaving office for the talk circuit get paid as independents. Your landscaper and handyman are freelancers.

Most artists, for example, work on gigs as a matter of course. Often they work on multiple levels, dividing their time between commercial art and serious endeavor – such as musicians who play good-time Dixieland one night a week and innovative jazz on another night.

We respect artists in America – at least some of us do – but we don’t worry about the precarious state of their economic survival. It’s only when the same predicament hits the mainstream economy, as it is doing at present, that it becomes a perceived problem and a big story.

In her post, Tina conflates freelancers with part-time workers. They’re different. As corporations find it to their advantage to downsize by kicking employees out the front door and inviting them back in through the rear door as associates or consultants the long-standing muddle about self-employment and part-time work is growing more confused.

Most accountants who sit in mahogany offices – I personify the type in my book, Self-employed Tax Solutions, as Sammy Segar, CPA – are clueless about the freelance life. The tax laws are written for the corporate world, and they are trained solely in the tax structure of the corporate world. When they see an honorarium for a speech they treat it as “Other Income” rather than as “Earned Income.” And you know what? On earned income you must pay Social Security and Medicare taxes. If you’re an indie – same tax, different name. It’s called self-employment tax.

This apparently eluded the tax preparer who worked on Treasury Secretary-designate Timothy Geithner’s tax returns, and thus put his appointment to the Obama cabinet at risk. The state of the new economy means the accountants have to get out of their mahogany offices and into the present economy to see what self-employeds have been dealing with their entire indie lives.

Self-employed people get screwed not only by the accountants and the tax laws, but also by the banks, the mortgage brokers and all the other monotone gray elements of the corporate W-2 side of our economy. So maybe the grim economic forces that are creating a gig economy will at last help that unorganized and unorganizable mass of freelancers. Because so many people are scrambling into the same boat with freelancers, an opportunity has opened up for a New Deal for the Indies.

June Walker

You must be in it to make money not to reduce your tax!

June --

I am a Full time IT Professional, and part time artist. I've been painting/selling my artwork for many years.

I'm just starting to think about how I can use that to my advantage during tax time.

My question is will your book be useful for me, as I'm not self employed - I have a job, but I'm also an artist? I was wondering if I should create a company to leverage against the income I get from my full time job, or should I just file my taxes differently.

Do you have any information on the topic? I paint dance-themed art. As an artist, can the creative material gathering process be included in a deduction. For example if I go to a salsa event and take pictures so that I can use that material for a painting that I will create? Is there a limit to this? For example I'm planning to go to a dance cruise - take pictures for creative material, network with people regarding my art, and give out business cards, would this be a business expense?

Would I have to become a company first?

Thanks, Alla
Philadelphia PA


Dear Alla,

Read my post, Hobby or Business? If it's fun, be careful. and you will see that in order to have a business and deduct expenses that are greater than your income, then you must have a profit motive. You must want to make money. Tax reduction is not a profit motive.

I also recommend that you read my most recent eLetter, Ways Through the Maze. The column, "Only Suckers Pay Taxes,"answers your question.

If you make money on your painting then you have taxable income even it you treat your painting as a hobby rather than as a business. My book, Self-employed Tax Solutions, explains the difference between hobby and business and also covers the tax and financial basics about being -- or thinking about being --self-employed.

You ask about forming a "company." Do you know what you mean by company? You need to do some homework. Use the search facility on my blog and in my site . For starters search "entity," then "LLC," then "corporation." You don't need to form anything to be a painter in business. You simply have to be doing it fto make money.

Whether you may or may not deduct your creative material gathering depends on how business-like you set up your indie endeavor. Right now, were I your tax pro, I would say no. Ask again after you've read and learned about indie business and decided how business-like you want yours to be.

Good Luck!
June

Software Cannot Replace Experience

Hi June,

I am a clinical and consulting psychologist who has been a sole proprietor for over 20 years.

I've started working on my taxes and have a question.

Earlier this year I spent $1,062 to purchase the latest version of a psychological test that I use regularly in my practice. I had thought that it would be considered an "office supply" and that I could write off the entire amount as a supply expense. But in using TurboTax, it asked me about a depreciable asset. It seems that by definition (something that has a life of more than a year but will become obsolete eventually) this test is not an office supply, it's a depreciable asset. In the end, TurboTax told me that it was a "special" depreciable asset that I could take a one-time deduction for, of only $561! How do I legally handle this - asset or supply?

Thanks,
Dr. Mark
Fairfax Station, VA


Dear Dr. Mark,

You see, I've been feeling really depressed. Suicidal actually. I bought this software program Mind-Mend. Says it has taken 20+years of psychiatric experience and rolled it up into this software program. There are 10 steps to avoiding stress. One step says do 15 minutes of meditation each day. Another step has me stand on my head for 10 minutes so that my circulation increases. My gym instructor says I should not stand on my head because of an old army injury. I am confused, what should I do?

As a doctor you might tell me that stress and suicidal tendencies call for different levels of treatment as well as different levels of urgency and that I should speak with a professional. You might also say that there is no way that 20 years personal experience could be put into a software program and have the same success rate as weekly visits with a therapist when treating something as complex as suicide.

This is my round-about of saying what I have said on this blog many times before: A software program written for the simple world of employees cannot replace a tax pro experienced with indie tax situations. Search "turbo tax" on my blog or go here for more info tax pros - tax prep fees - tax returns (21) .

Software is a supplies expense in almost all circumstances.

Best,
June

Spouse On A Business Trip

June --

I am a Medical Physicist. I started part-time independent consulting in 2004 while still employed full-time. Consulting has increased and as to Jan 2008, I will be full-time independent (sole-proprietor). I just found your website--what a great resource, Thank You.

In Sept 2008, I attended a professional conference in Boston. My wife joined me on the last day and we spent the next several days in New Hampshire. I have employed her to handle finances and admin since 2006. Naturally we discussed some of the business aspects of the conference while we were in NH but that was not the purpose of the trip for her. Are any of her expenses deductible?

Is there a best mechanism to substantiate deductibility for spouse/employees for business conferences?

Thanks, Joe
Dallas, TX


Dear Joe,

I assume from your email that your wife is your employee. If she is then you may deduct all the costs of your employee's travel expenses in the exact same manner as you may deduct yours as the employer. So, if Boston were the business portion of your trip and New Hampshire were the fun, or personal, portion, then you cannot deduct the New Hampshire costs nor could you deduct the cost of your employee's New Hampshire travel.

When you take an employee on a business trip you must be able to show the necessity of having that person with you. Whether it's to transcribe notes, schedule appointments, wine and dine associates, there must be a clear business reason for attendance. This is especially so if the employee is your spouse.

If your wife-employee handles only your recordkeeping and secretarial chores then you must find a reason for her to accompany you. For instance, is she a good researcher? Can she investigate primary source documents for you at the university's library for non-circulating material while you attend the conference?

Best,
June

Hobby or Business? If it's fun, be careful.

Well, here I am making another exception and taking on a unique situation. But since 2009 is to be the year of change, why not? And, I do think that there is enough in Guren's situation that many of you will get something from my answers. My response is in orange.
-- June


Hello June,

My wife and I are avid travelers and, although we have settled down and each work full-time as employees at different companies, we plan to start a travel blog with the goal of making enough money to fund even more traveling.

We will file a dba and work as a partnership. A partnership is the least tax advantageous structure for a husband and wife business. For some basics on that, read these posts payroll -- spouse as employee .

1 - it seems too good to be true that we could deduct the cost of our travel and other expenses against our blogging profit and, if there are losses (and I'm sure there will be in the first few years), deduct those losses from our regular employee incomes. If the losses are great enough, it would be like the IRS paying us to travel. Or am I dreaming? Your dream may become a nightmare unless you show a true profit motive. Your goal cannot simply be to save enough in taxes to pay for your travel. That very much has the ring of a home-made tax shelter to me and I'm sure would make the same sound to the IRS.

Your profession -- travel blogger -- falls into the same genre as skiing and photography and other activities that people do for fun and so the proof that you are in it to make a profit must be stronger than for other professions such as massage therapy or IT consultant.

The IRS lists nine guidelines that will help determine whether you’re goal is to make a profit. No single item on the list settles or resolves the issue, and the list includes questions such as:

Do you carry on your work in a businesslike manner? Do you keep accurate records of income and expenses? Have you had success in carrying on similar or dissimilar activities? Have you taken a similar activity and converted it from an unprofitable to a profitable enterprise? Have you had general success in running other kinds of businesses? Did you write a business plan on how your blogging is going to make money over the next 5 or 10 years?

2 - As long as we have losses, are we forbidden from contributing to a SEP retirement plan? For a SEP, and any other pension for self-employeds, the contribution is determined by net income. That means what you are left with after deducting business expenses. A loss means no pension contribution for the sole proprietor. If your spouse is your employee, then a loss does not have that same relationship to the spouse's pension contribution.

3 - any idea of what a indie-friendly CPA should charge for an initial consultation? Between $150 and $350 per hour. Depends on the geographic location and expertise of the tax pro.

I hope you're able to help!
Thanks in advance!
Guren
St Louis, MO

A related comment: There are so many books and sites that tout self-employment as a way to pay no tax. This is a concern of mine. I'll say more about it in this month's eLetter Ways Through the Maze. If you are not already on the mailing list and would like to subscribe, you may do so here.

--June

Son Has A Landscaping Business

Happy New Year, Indies!

It is not my policy to answer questions that are unique to one person's situation . I have made an exception here because I think this is a cool Q&A to start off the new year. My answers are in orange.

-- June


Ms. Walker,

Your book has been very helpful to us -- equally understandable by a teen and his OLD, almost 50-yr old dad. Ohmygosh, you think 50 is old!

Our 16-yr old son has mowed lawns for neighbors since he was 10 using the unregistered name "Clean-Cut Landscaping Services" the last four years. To get him started, we trash-picked a lawn mower and had it rebuilt for him. He repaid us and has since purchased all his equipment with cash, grossing $30K last year. Impressive.

He now uses a 8'x12' shed and half our 22'x24' two-story barn garage for his ~20K worth of mowing, leaf collection, snow blowing, mulching, planting, hedge, and tree equipment. His younger brother is now working with him, pulling the 8' bike trailer with equipment that the older one had pulled with his bike before he purchased his commercial riding mowers. A family business is good.

He is home schooled and consistently scores extremely well on standardized tests. His routine is starting his school work at 0530 and finishes at ~1300, with some variation for outside coop classes. With No-Child-Left-Behind as policy in public school the past few years, it's no surprise that home-schooling has been on the rise.

Our questions follow:

1. Can we charge him rent on the shed and garage storage space for his business equipment and he deduct that as a business expense? That would help to compensate us for what is now used solely by him. Yes, if you claim the rent as income.

2. Presumably he could not use such a deduction until he is actually paying us? Correct. That is, we cannot prorate the tax, repair, utility, etc. proportion of business-use of our total living space (house, garage, and shed) described in your book until it is a valid expense to him? You are asking about a home office deduction. You can not take a home office deduction because it is not your business.

3. Can we charge him for the sizable laundry cost required for his business and he deduct that? He currently buys his work clothes and shoes. Think of it this way: Were he to pay a laundry service to clean his clothes he would deduct the expense; the laundry service would claim the amount paid as income. You would need to claim the fee for laundry service as income. Depending on your income and tax bracket it may or may not be a tax advantage to have him pay you.

4. Can he claim as transportation expense the mileage from his garage and shed storage area to those neighbors where he conducts his work? He uses his large, 5' deck riding mower to transport all his equipment. His 50-customer clientele is primarily within a 1-mile radius, but for some jobs he has to make multiple trips to transport all the equipment required for that job. Yes.

5. To avoid withholding social security taxes, to his younger brother, will his brother also need to meet the criteria for a sole proprietorship? I assume that would be the simplest arrangement for the two. It's not a question of simple. His younger brother is his employee.

6. Finally, you mention in your book the option of fully deducting the cost of purchased equipment the year in which it was purchased. Are there any particular requirements that he must meet to do that? That's a tax preparation how-to question regarding depreciation. I do not give tax preparation instruction.

Thank you.
v/r Jonathan (dad) for Abraham (older son) and Moses (younger son)
Glenside, PA
You are welcome. Sounds like you have great kids. Kudos to the parents.
June Walker