Husband-Wife Business? Don't set it up as a partnership.

June,

I am preparing to take the plunge into SE and your book Self-employed Tax Solutions book has been an excellent resource.

Due to the work I do and subsequent contractual liability concerns, it was in my best interest to form an LLC, which I did as a single member.

My spouse will work in this venture in a part-time/full time business management capacity while I provide billable consulting services.

Are we better off with my spouse as a member, thus a partnership LLC, or as an employee in a single member (sole proprietor) LLC? I want the maximum liability protection, and equal "ownership" but do not want to give Uncle Sugar anymore than I absolutely have to. Since we file jointly, I'm thinking the tax advantage lies with the sole proprietor option but need your advice.

Thank you in advance.

Dean from Fort Collins, CO


Hello Dean,

Very smart move -- getting information before you make a decision!

An LLC treated as a "disregarded entity" is a sole proprietorship.

The most tax advantageous business structure for a husband-wife business is that which has one spouse as the sole proprietor and the other spouse as an employee of the sole proprietorship.

The least tax advantageous is a husband-wife partnership.

For an understanding of the advantages read my posts in the category payroll -- spouse as employee.

Glad my book is a good reference for you. Please tell your indie friends and colleagues!

Best,
June

No Clothing Deduction

Hi!

I've just discovered your website and I think it's great! I'll be reading it regularly for sure.

If you have a small boutique and you are the owner and naturally you take some of the clothing home to wear it yourself. From a business perspective it's important that you wear your merchandise - it makes it easier to sell it, you need to know if it holds up, you need to know if it fits right. I know you would have to pay use tax on the cost of the merchandise that you wear. But can you deduction the cost as a business expense? And if so what would you call that account? I thought of research and development, but that doesn't sound quite right.

-- Kaylyn


Hello Kaylyn,

The IRS is a stickler on this. The answer is no, you cannot deduct these clothes because you wear them in your everyday activities. Were you to wear something for a specific period of time, keep a written record of when worn and the result of the test, then you'd be able to take the deduction.

Take a look at this post Clothing and Make-up as a Business Expense .

Best,
June

Medical Insurance Deduction for Indies

Hi June,

I like how you write, it's fresh and easy to understand.

I have a question. I'm considering quitting my job and working for myself doing free-lance technical writing at home. My big fear is the cost of health insurance. Any tips?

As a sole proprietor, can I deduct ALL my health insurance premiums and out of pocket expenses? If yes, then basically does that lower my taxable income? Can you give me an idea if that would make my health insurance premiums about equal (after all taxes paid at year end) to what I would have paid working for my current employer? Currently I spend $130/month, but I received an estimate of $250-$400/month from Blue Cross/Blue Shield as an independent person (depending on the type of health plan chosen).

Is there any other way to recoup that insurance premium besides a tax deduction, too?

Thanks.
Holly from Warrenville, IL


Hello Holly,

Let me give an overview of how medical deductions work.

If a taxpayer is not self-employed then medical insurance premium costs and all other medical costs are deducted as a personal expense in what I call "the guts" of the tax return. If these medical expenses do not come over a certain minimum or if the taxpayer's income is so high that the medical expenses don't meet another threshold, then the deduction for medical expenses is lost.

If a taxpayer is self-employed, here's the difference: Medical insurance costs are deducted on "the front" of the return and immediately reduce taxable income. Other medical costs are still deducted as a personal expense in "the guts" of the return. No medical expense is a direct deduction from business income.

There is no way, without analysing your personal tax return and projected income, to tell whether your new premiums would actually cost you any money. Why not calculate as if you simply had an additional $270 [400 - 130] cost per month and see if you could handle that?

Glad you like my writing. Thanks!
June

Artwork is not a deductible business expense ... even for artists.

Hi June,

I'm an oil painter who is being audited by the IRS. They are refusing to allow my deduction of oil paintings I have purchased from galleries. I have receipts for all of these purchases and have provided them to the IRS. I am deducting them because I believe they are necessary for my business. These are artists whose work I admire and learn from. From these paintings I can see how they solved similar problems. I can also use these paintings as examples when I teach. One of these painting is from my teacher's teacher who is deceased and this is the only way I can learn from him.

What do you think? Should I be able to deduct this from my business? I make my living as a painter, and I feel this should be valid. I'd appreciate any comments you have and if you know of a precedent for this?

Thank you so much for your time.

Cheri from Sandi Park, NM


Dear Cheri,

The IRS thinking is that art treasures and antiques do not depreciate in value and so you may not deduct their cost as a business expense.

There is ambiguity about something such as an antique desk used in your office or a musician's rare banjo. If they are used and subject to wear and tear they may be depreciated. That is not the IRS regulation however. It is from a tax court case only and so could be rejected in an audit.

I spoke with the IRS about this last week and the response from that particular IRS employee was: Yes, you may deduct the cost of the oil painting if it is part of the ordinary and necessary costs of the business. Therefore as long as the IRS has accepted that you are a self-employed artist seeking to make a profit you may deduct the costs of artwork as teaching tools. His opinion is not the one generally accepted by the IRS!

My experience has been that the IRS will not allow the deduction. I know of no precedent to the contrary on oil paintings or sculptures.

Of course what would make sense is to treat artwork like houses and other buildings. Deduct the cost and pay tax on the gain when it is sold.

Wish I had better news for you.

Best,
June

Work-at-home expenses allowed without a home-office

Hi June,

I am a self-employed film and video freelance editor and work out of my home as well as work on-site and go back and forth between the two sometimes. I can not deduct for a home office though because I share a one bedroom place with my fiancee.

My question is, even though I can not claim a home office, can I still claim expenses incurred from working out of the home, i.e. my editing system, my laptop, my editing software, my supplies, my entertainment expenses, etc? I certainly hope so. Please let me know.

Thank you for your time.
Sarah


Hello Sarah,

The short answer: Yes, you may deduct every one of the expenses that you questioned.

So many indies get mixed up on the relationship of office-in-the-home to other expenses such as office supplies and equipment. Even the experts get it wrong. Here's an example of how wrong they can get it --
It's tax time so ... beware of bad advice from the real-life Sammy Segar, CPA

Simply put there is no relationship between home office deduction and the deductibility of office equipment or supplies or any other business expenses. As I explained in the above noted post: " ... the deduction of office equipment and furniture has nothing to do with a home-office deduction. If you use a computer only for business it qualifies as a business deduction, even if it sits on your kitchen counter. If you have a printer perched on your home-office desk it does not qualify as 100% business use if your kid borrows it to print his homework. An ergonomic desk chair used only when you’re working at your business computer qualifies for a business furniture equipment deduction even though it, too, sits in your kitchen.

Where business equipment is located or used in the home is not relevant to a deduction. Nor is its use related to the size or even existence of a home office.

The same applies to all business expenses. In my book, Self-employed Tax Solutions, I use the following example: "Telephone expense is not directly related to office-in-the-home expense. You may deduct for a phone used in your residence even if you do not have an office or studio in your home. If you do claim an office-in-the-home deduction don’t think that somehow office size and phone use need to match. They don’t. Your home office may take up 10% of your residence but you may use 88% of your phone for business. No correlation, no problem."

-- June

PS: Take a look at Shared Rent: You may still deduct for home office . You may have a home-office deduction.

Wacky payment method?

June --

I have been a sole proprietor home care physical therapist for 10 years.

Can sole proprietors be paid via direct deposit in NY? We were always told no, but now one of my clients ( a hospital) wants us to sign up for direct deposit. I'm leery. Any advice?

Frank -- Franklin Square, NY

Hello Frank,

"We were always told." Told by whom for goodness sake?!!!! And for what tax reason were you not allowed to have your payment deposited directly into your checking or savings account?

I get emails where indies have been told a lot of wacky things, and let me tell you that's up there with the wackiest. You may be paid in and by anything -- camels, dollars, rubles, gold, check, credit card, cash, barter, wampum, even direct deposit into your bank account.

And it's all income that must be reported on your tax return.

You must email me back and tell me who told you that.

Best,
June

Husband & Wife Working Together: Incorporate or Not?

Dear June,

I am a freelance designer. My husband works for an advertising company. Once in a while he helps me out with my work. My friend's accountant told her that I'd save a lot of money if I incorporated. Should I incorporate and put my husband on my payroll? I'm confused because I don't really know how a corporation works.

Thanks.
Janice from Ohio


Hello Janice,

Do not incorporate unless your personal tax pro analyzes your unique situation and gives you specific, understandable reasons why it would be better for you.

Here's a snapshot of how a corporation may handle income:
In a corporation, the tax benefit of retained earnings -- that's corporate profit that is not distributed but kept in the corp for future business spending -- comes into play only when you make a lot more money than you need to live on. By doing this, you leave some of the earnings of the corp in the corp and do not have them available for living expenses.

In your corporation you would earn money as a designer. These would be your wages. Your husband would earn wages. The corporation would have a profit on which the corporation -- that's you -- would pay tax. The corporation profit -- in the form of dividends is distributed to you.

On yours and your husband's tax return you include your wages, his wages and the dividends. You pay tax on that income. Note that on the dividends, the corp -- you -- have already paid tax once. Now you will pay tax on those same dividends again.

You must pay whatever fees your state requires for setting up a corp. You must pay an accountant to help set up a corp and every year to prepare a corporate return for the feds and also for the state. There are various required papers, such as corporate minutes, that you'll need to keep.

All this is a hassle and expensive and so you don't want to do it unless you must.


When you have a sole proprietorship and you hire your spouse as your employee this is what happens or may happen:
-- Your wages to him simply move the income from one part of the return to another. No tax change. -- If he must accompany you on a business trip, his expenses are business deductions. Not so if he were not an employee.
-- You may provide him with a health plan that covers his family [that includes you]. All family medical expenses then become deduction against your business income.
-- You may give your spousal employee dental coverage, life insurance, disability coverage, a pension -- all are deductions against your business income.

And, if he works out really well, you may give him a raise.

Keep in mind: A sole proprietorship may be an LLC. Read about it here Sole Proprietor as an LLC

Best,
June