Cash Basis

June --

I am an RN case manager.

In 2008, I received one check that went on a 1099, however, I became an employee of the same company on Jan 1.

Am I right in assuming that I can't deduct any expenses for that check since it was earned in Dec, 2007?

Mary
Knoxville, TN


Dear Mary,

I think I understand your question but am not sure so I'll just give you some info that may help you out.

You are a cash basis taxpayer. That means that you deduct the expense in the year incurred. You claim the income in the year received. If you had self-employed expenses in 2007, that's when you should have deducted them. If you were paid in 2008, that's when you claim the income.

There are ways to change your accounting method from cash basis to accrual. In your situation it doesn't seem worth it.

-- June

When To Deduct An Expense

June,

I have very much enjoyed your posts and blogs and will be purchasing your book.

I have a question about inception vs separation. My accountant told me that I am able to claim expenses when I actually put an expense in service and that its independent of when they were actually purchased.

The example I'd like to speak of is my wife's business of a kennel. She has purchased animals in the year previous years but never claimed the expenses of those purchases. Recently some of these animals have passed on ( this I am calling separation ). Since they were not claimed on any returns prior is it acceptable to claim the loss now, even if it was several yrs back that they were put into service?

Best Regards,
Mark


Dear Mark,

For a cash basis business, you deduct an expense when incurred, meaning when you paid for it. You claim income when received.

I will assume your wife's business is cash-basis.

Equipment must be deducted -- when available for use in the business, not when it is used.

Supplies for general use -- when purchased.

Supplies for inventory -- depends on the kind of inventory method you have setup.

What your accountant is suggesting doesn't seem correct. All animals should be treated in the same way on the tax return. You may not pick and choose for your tax advantage.

Your accountant must do the research to get a definitive answer. If he is not already a member recommend http://www.natptax.com/. That organization is great with tax research.

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

Best,
June

Cash vs Accrual Recordkeeping

Hello, June:

It is very nice to find this website to help us new self-employed guys. I am a full-time employee, and recently started to be a part-time contractor.

My problem is that I started working for that contract in Dec. 2007, but did not get my first payment until Jan. 2008. My question is: May I still be able to deductible some cost (like travel) for year 2007 (I do not think I will get a 1099 for year 2007)?

Thank you.
Laser
Minot, ND


Laser --

As long as you are in business to make money it doesn't matter whether you have yet received the money, you may deduct your business expenses.

There are two methods of recordkeeping: Cash or Accrual

As a self-employed in business you get to choose when to report your income and expenses. Don’t get too excited it’s not as liberal a choice as it sounds.

You may opt for a cash basis method of bookkeeping. This is one that claims income when it is received and deducts an expense when it is paid.

Or you may choose an accrual basis. This bookkeeping method claims income when the client is billed, regardless of when the client pays you. You deduct an expense when you become liable for it – which is usually when you get the bill.

You must use the same method for both income and expenses. The cash method is simpler and is used by most self-employeds.

There are examples of both methods in my book Self-employed Tax Solutions .

-- June

Are all expenses deductible in the year they are paid?

Hi June,

I am a cartoonist from Parsippany, NJ --5 years.

I have 3 little questions that all seem to fall under the category of "Are all expenses deductible in the year they are paid?"

1) I usually pay my PO Box fees in the year I use the PO Box, but because of a rise in fees, the Post Office encouraged me to pay ahead, so I have paid for 18 months in 2007, but only used it for 12 months.

2) Advertising: I bought business cards, stickers, and other small items for advertising my business, including Holiday Cards (featuring my artwork). Is the total cost deductible as advertising, even if I have inventory left over? It will take me years to hand out a thousand business cards!

3) Software: I thought that you had mentioned somewhere that software had to be amortized over several years, but cannot find that reference now. Can I deduct the cost of software and software upgrades as supplies in the year purchased?

I truly appreciate your advice, and your time.

Thank you very much in advance,
John

Hi John,

Hello to Parsippany. I lived in NJ much of my life. And my husband covered Parsippany-Troy Hills for a local newspaper way back when.

As a cash-basis taxpayer, yes you may deduct all the expenses you question as current, in the year paid. At one time software had to be amortized -- cost spread over a number of years -- but no more. Take the cost as a supplies expense.

A reminder about cash-basis: It's income when you get it, not when you bill it. It's an expense when you pay it, not when you receive the bill.

Another reminder about December expenses: Paid by check or bank credit card, then it's considered paid regardless of when your check clears or when you pay your credit card.

Best,
June

Stage Mom -- sort of -- asks the questions for child model

Ms. Walker,

I bought your book Saturday night (Self Employed Tax Solutions - 2nd Edition) and highlighting stuff as I go, LOVE IT!!!!! I am only on page 52, soaking up every word you say!
Great to know. Thank you.

I HAVE TWO MAIN QUESTIONS:

I am in a really strange situation and can find ABSOLUTELY NO BOOKS ON THE SUBJECT MATTER! I have a daughter who is 13 and studying to be an actor/model. All the contracts we have signed say she is an "independent contractor". I understand that means she is responsible for own taxes, at the age of 13. ??? Yes.

Okay her taxes? or my taxes? Her taxes.

If she does a job for a client, the client pays the agent, the agent pays my daughter and then daughter has to pay a percentage (as stated in our contract) to her talent manager. Is there book on this stuff? Not sure what you're asking. If you're asking is there a book on this subject. yes, mine. The one you are reading. Your daughter is self-employed.

If you are asking about expenses, then the payment to the talent manager is a business expense against your daughter's self-employed income paid to her by her agent.

Holy cow! My head is spinning. This is our first year and how no idea what to expect when tax season rolls around.

And since I am paying the Talent Manager a commission, no taxes removed, is there something I need to worry about there? Your daughter, that is using her name and social security #, must send a Form 1099 to the talent manager at year-end. Here's some info 1099s W2s W4s W9s .

And are they deductible in the year occurred or year actually paid, When paid because your daughter is a cash-basis taxpayer. Read this post Cash vs Accrual Recordkeeping .
as most of the work here in South Florida is done October through March.

If for some reason she gets no work this year (2010) and I am told most of her work will probably be in January (2011), do I have expenses I can deduct? Yes. 2010 expenses are deducted in 2010 even if there is no income.

I am keeping records best I can but now after reading only half your book, I see I missed a lot of expenses - DUH! Keep on reading.

Thank you.
Annette


Annette, you had many, many more questions. Stop spinning. After you've finished reading my book, go talk with a tax pro. Ask your daughter's agent or talent manager to recommend someone.

Best,
June

It’s December – Do you know what your taxes are?

It's December, yet there is still time for indies to take a few steps that will make tax-filing season less distressing.

Which steps to take and the order they are taken depend on where you are and where you’re headed. So before you can better your tax situation, you need perspective on your current tax outlook. The way to get this perspective is to compare your expectations or planning for the year to what has actually happened.

If you've made more money than you’d expected or planned for, you may want to reduce your income with more business deductions or pension contributions.

On the other hand, if your income is lower than projected, maybe you can bring in income earlier than you expected or defer some deductions until next year when you’re determined to make more money.

The very first step: Start now! Get your tax papers together. More time means more complete records, fewer missed deductions, and the opportunity to discuss tax strategy with your tax pro. In stead of waiting until the hour has struck, ask her for a review now and get a projected tax total. If you hesitate because of the cost of the consultation, think about this: the more you get done now the less you and she will have to do later. Overall cost may be the same, or even less! And if it does cost you a little more it’s worth it if it helps to improve your total tax picture – and accounting fees are a deductible business expense.

Once you have an idea of your tax position, you can take steps to change it.

Too High Income
If your income is higher than expected or your deductions are skimpier than you’d like, here are some tips.

Look for more business deductions. Are there expenses or purchases planned for the future that you can make now? What about the scanner or desk you really need? The computer that you intended to buy next year?

Fine, you say, but I don’t have the cash for a major purchase. Well, there’s a way around that. Charge your purchase to a bank credit card. For instance, a $2,000 piece of equipment purchased with a bank credit card before the end of the year gets you a $2,000 deduction for this year even if you make no payment on it until next year. Keep in mind, however, that it has to be a bank credit card like MasterCard or Visa -- not a store credit card.

If you’re a cash basis taxpayer, which most of you are, a check written on or before December 31st for a legitimate business expense is a deduction for this year.

Of course, never spend just for the tax break You won’t get a dollar for dollar tax savings. Here’s a general rule: Unless you are in a very high tax bracket, a $1,000 business deduction will save you about $300 to $400 in federal income and self-employment taxes and state tax.

I use the term pension plan and retirement account interchangeably. For an artist or writer with no plan of ever retiring I call it a freedom account because it allows the freedom to change ideas and plans in the future.

So it’s time to re-evaluate your pension plan. The pension laws and regulations have had a complete makeover. You may be able to decrease your tax significantly by starting a pension or changing the kind you have. Be sure to investigate a relatively new pension plan that goes by several names -- the UNI-K, the Solo-K, the one-person-K. It’s easy to set up, flexible and, if established with the right brokerage house, inexpensive . Careful though: some brokers and investment people who don’t usually work with self-employeds may not be familiar with the UNI-K. They will try to steer you to the corporate world 401-K, which is the wrong plan for indies. Make sure that your tax or financial professional has a grasp of pensions that work well for indies.


Not Enough Income
On the flip side, what if you had a bad year and made less money than expected? One of the nasty side effects of a bad-income year is that you may be entitled to deductions that get you no tax breaks. Those deductions would come in handy next year when your IT business takes of or you've finally been accepted to the regional juried show, and your income increases.

Here are some possible moves to make in the face of a downer income year.

Delay purchases if you can. This is one of the advantages of understanding your tax situation before filing deadline – not that tax matters should determine all your decisions, but that taxes should be factored into them. If you can wait until next year when there’s a promise of more income, wait.

If you have to purchase a piece of equipment now because the sale ends on December 25, buy it now. According to IRS rules you don’t have to take the deduction in the current year if the equipment was not available for use, So if the set up of the scanner or computer must wait until the holidays are over and the guests leave then it is not available for use and so it is not a deduction until next year.

Do everything you can to get your income up. Offer discounts, have a sale, make an extra effort to get the money owed you, pester the gallery owners or consignment shops or laid-back-clients that have been slow in paying or who normally pay after the first of the year.

I said earlier to take a look at your pension if you’re having a good year. And if you’re having the opposite kind of year, look just as hard. Several pension plans require a contribution. You may not need to make a contribution in the current year because you don’t need to reduce your income. And in a low-income year you may not have the funds to make a pension contribution. The solution may be to change to a different type of pension plan. And now, before the year is out, is the time to discuss that with your tax pro.

This month you will see a lot of last minute tax tips posts and columns. Most of them will tell you the same old stuff: Clean out your closet and give the clothing to charity for a big write-off. It is a good idea to free up some closet space and do a good thing with your discards. But that is not going to have a big impact – if any – on your tax situation. picture. So, start now to develop your 2007 tax picture and you'll have a better perspective into 2008.

In future posts I’ll mention tax tips from other folks that are worthwhile. Keep an eye out for them.

June Walker

You are a business. Treat what you do as a business.

June --

I live overseas and I have been working as an independent consultant for three years. in May of 2009, I accepted a job as a subcontractor to a subcontractor (a research wing of a foreign university in Eastern Europe). The project was a disaster and the lead contractor has essentially hogged every cent and has not paid the subcontractor--very shady!

I am not getting paid. I have fought and continue to fight but without taking drastic more expensive actions, I think I'm just screwed. It is ill advised and expensive to go to court here and I don't want to make this battle so public in such a small place. I am owed 10,000 dollars, which is no small money for me, as the job ended early (I was originally expecting to earn 20,000 from it). Now I am getting 0 AND it cost me some money to actually do my work as an environmental consultant.

I don't want to go to court to resolve this, as it will cost me more money and time and this is a foreign court that is unpredictable.

My question is, can I deduct my losses (the $10,000 I was supposed to get paid) against the taxes owed on the $8000 in earned income for 2009.

I have a signed contract and stop work order I issued when it became clear I was going to be paid squat. What would I need for documentation to prove I'm not getting paid? . Also, now that everything has gone so sour, no one will issue anything in writing anymore so if I need a piece of paper that says, there's no way in heck you are getting paid, that might be difficult to obtain.

Secondly, how would I claim these losses--is there a particular US gov form for losses. Thirdly, how much more likely get audited will I be by deducting big losses against my measly 2009 earnings.

Lets say I finally and surprisingly get paid next year at some point--what would I do if i had already deducted in from my 2009 taxes.

Is this common for independent contractors to find themselves in such a position, where it is too expensive and hard to go to court and the Indie just comes to terms with not getting paid.

Dejected and Taken Advantage of Indie, Jennifer


Dear Jennifer, A Dejected and Taken Advantage of Indie,

I apologize for cutting so much from your email. I wanted to make it accessible to my readers because yours is not an uncommon situation. Many indies get stuck for the bill. I am sorry this happened to you and to so many others.

What you don't want to hear is that you allowed yourself to be taken advantage of. If it were a $1000 job I could understand your doing the work before getting paid. But $20,000!! And doing $10,000 worth of work with no payment. In all that paperwork that you have you should have included a payment schedule. Something like: 1/4 of the work done, get paid 1/4 of the money. No more work until you get paid.

So, it happened to you once. Don't let it happen again. You are a business. Treat what you do as a business.

And the other thing you don't want to hear. You are a cash basis taxpayer -- explained in these posts -- so you can do nothing with the loss. You cannot deduct it. You may deduct any expenses that you incurred.

Best,
June

Business Expenses on Credit Card

June:

If I bought a computer on credit, and have payed off some off it, how do I claim a portion of my computer?

Michael from Atlanta


Michael,

Any charge made on or before December 31st to a bank credit card is an expense for that year, regardless of when the credit card balance is paid. For a store credit card it is an expense in the year it is paid. So if you bought your computer at BestBuy 2010 on a BestBuy credit card and paid for only half of it by the end of the year, you may deduct only half the cost on your 2010 tax return.

A similar treatment applies to expenses paid by check. For cash basis taxpayers (you’d know if you weren’t) a check written on or before December 31st, regardless of when it clears your account, is considered paid in the year it was written.

A hint for recordkeeping: Most bank and credit card monthly statements do not start on the first day of the month and end on the last. They straddle months and therefore they straddle years – for instance, December 14, 2010 through January 13, 2011. When you have a monthly statement that straddles a year, make a copy of it. Put the original and any paperwork (receipts, deposit slips, canceled checks, etc.) dated December 31 or before with the earlier year’s records (2010); put the copy and all paper transaction records taking place January 1 or later with the later year’s records (2011).

Visit here for June's 2011 manual recordkeeping how-to guide: The Confident Indie: Five Easy Steps

-- June

Audit Choice

Hi June,

Graphic design / music. Three years.

I'm being audited by the IRS this year for 2006. I don't know why. I made nothing. My accountant says it's because I made $1000 but we deducted $3000. It was the year I bought my laptop. I'm so glad I purchased your book, Self-employed Tax Solutions, a year ago.

I've been gathering my receipts and realized that about 5 of the important receipts i used for 2006 actually are dated jan-mar of 2007. If didn't use them for 2007 tax year, is it okay to have used them in 2006? I should have looked more carefully.

Best,
Sandy


Hi Sandy,

Just about all audits are randomly chosen. You might also think of them as chosen from batches. An unmarried photographer with a loss for a several years may be in one batch. Another photographer with several years of loss but married to a high-earning spouse may be in another batch because the situation may look like a home-made tax shelter -- an expensive hobby supported by a spouse. So, none of us laymen knows why you were chosen. I doubt your accountant is correct.

You are a cash-basis taxpayer -- explained here. You cannot use 2007 receipts for 2006. Yes, you should have been more careful. As careful as you would be were you designing my promo material and had to approve proofs before having 5000 printed.

Best,
June

3 Rules for Home Office Expense ... everybody's asking about them

As an indie in business you may work anywhere you want. You may rent an office or studio, purchase an entire building in which to set up shop, or work out of your home. Whatever suits your situation. If you happen to work out of more than one place you may be able to deduct expenses for all of them.

There’s an old husband’s tale that contends deducting office-in-the-home expense on your tax return is a red, waving flag, so don’t do it. That’s hogwash. If you use your home for your self-employed business, then, by golly, don’t be afraid to take the deduction. By deducting expenses for your home workspace you’ll pay less tax. The only caveat: play by the rules.

The IRS has relaxed the rules in recent years, and they are simpler than you may have been led to believe. There are now only three home office rules.

RULE #1: Exclusive Use
The part of your home used for business must be used exclusively for business. It does not need to be an entire room, but may be a designated area of a room.

• If Lily Legal writes her briefs at the dining room table but also has dinner parties there, well, she has to forgo any deduction for the dining room.

• If Victor Visual and his wife Faye Fabrique, a textile designer, share the same studio-in-the-home, then neither gets the deduction because neither has exclusive use. (It seems unfair, but it's true.)

RULE #2. Used On A Regular Basis
The part of your home used for business must be used on a regular basis for business.

• Almost Sargent has a rented studio in town. He also has great light in a back room of his house. The room is always locked and seldom used. Once in a while he brings a potential buyer to his home to look at a painting and he uses the back room for the viewing. This is not regular use and so he cannot deduct the use of that room as a business expense.

RULE #3. Principal Place Of Business
Your home office or studio or workshop must be your principal place of business. The IRS term principal place of business is confusing. Even if you have more than one place of business, as long as the room or area in your home is used exclusively and regularly for business then your home office qualifies as a principal place of business if it fits any of the following three criteria.

** It is where you perform administrative tasks such as bookkeeping or scheduling.

** It’s a place where you meet clients, or patients, or customers.

** It’s a separate structure.

• Sally Ceramist rents a neighbor’s garage as her work studio. It’s always a mess. She has set up the small sunroom in her home as her showcase studio. Potential buyers come there by appointment to view her work. Although her works also show at a number of galleries throughout the United States Sally can deduct the sunroom as a home office.

• Kyla Chiropractor shares an office with an acupuncturist. They alternate days. Kyla does not keep patient records at the office. Each morning she brings from home that day’s patient folders. She keeps all her patient records, and her professional library, in a small barn on her farmland home. Kyla can deduct the barn.

There are exceptions to RULE #1, which requires exclusive use. The exceptions apply to home daycare businesses and storage of inventory.

What Can You Deduct?
Your home may be any kind of residence: house; apartment; condominium; cooperative; houseboat; mobile home.

And, all expenses for the portion of your residence used for business are deductible; that includes rent, repairs, utilities, security system, and upkeep expenses. If you own the home, deductions include mortgage interest and real estate taxes. If for instance 20% of your home is used for business then you can deduct 20% of all these expenses.

You cannot deduct lawn care unless there is an area that is for the exclusive use of your business.

The housekeeper that you have agreed to pay “off the books” – the one who takes cash only -- cannot be deducted as an expense. You can deduct the costs for a legitimate cleaning service or a housekeeper for whom you pay all payroll taxes.