Self Employed

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Practice Scenarios-- Give it a Try! Review each scenario, determine which expenses can and cannot be claimed. Then enter the return and compare your results with mine.

Practice Scenario 1- Woody Woodpecker-Lawn Maintenance
Client Information Sheet Completed 1040

Practice Scenario 2--JR Ewing--Tile Layer ***this return was being reviewed for possible edits.

Practice Scenario 3--Marge Simpson--Janitorial Services
Client Information Sheet Completed 1040

Practice Scenario 4--John Doe Sr. -Uber/Lyft Driver
Client Information Sheet Completed 1040

Self-employment Tax-- a way to explain to a client: If you were working for someone else & getting W-2 reportable wages, you know that you would have a portion deducted for Social Security & Medicare taxes. And, your employer would also be paying these amounts. Now if you're in business for yourself, you are both employer & employee, and it is your responsibility to pay both portions. This tax is based upon the profitability of your business as reported on Schedule C & not on your taxable income as reported on Form 1040. Hence, it is not uncommon for someone to owe no “income tax” at the time that they file, but still owe substantial self-employment taxes (& penalties, if quarterly estimated payments have not been made). Learn more under the Tax page

Some thoughts: Not required to know, but things I try to remember and share with clients when appropriate

First, I have seen clients try to come up with expenses that pretty much equal their income from self-employment to try and avoid any self-employment tax. I try to make sure all the expenses reported are legit by asking clarifying questions. If it is a cell-phone or internet, what percent of the month is the service used for personal vs business? Did they actually pay for it in the tax year?
Secondly, some clients don't want to be bothered, they just want to file their return and get it over with (they don't know the true implication of entering all that income without any expenses).
- Well, per IRS rules-- A self-employed individual is required to report all income and deduct all expenses. Revenue Ruling 56-407, 1956-2 C.B. 564, ... Rev. Rul. 56-407 held that under §1402(a), every taxpayer (with the exception of certain farm operators) must claim all allowable deductions in computing net earnings from self-employment for self-employment tax purposes. You might think this is counter productive by the IRS-- after all, if they claim less expenses, the taxpayer would pay more in taxes. Read on...
- Net earnings from self-employment are included in earned income for EITC purposes. There are many 'smart' people who "lie" about their self-employment income, or purposefully do not want to report all expenses so they can get the maximum EITC credit for their family size and filing status. According to the IRS 'fraudulent claims of self-employment income and business expenses to qualify for or maximize EITC are increasing.' This is why all income and all expenses must be reported-- so the correct amount for the EITC credit, if qualified, is calculated.
Thirdly, a lot of people do not realize that their gross earnings not only determine their tax for the year, the amount an individual earns a year is also used by Social Security Administration to determine monthly benefit amounts when that tax payer retires or applies for disability.
- To receive Social Security benefits, tax payers have to earn at least 40 credits (it is possible to earn up to 4 credits a year). You earn credits when you work and pay Social Security taxes. The number of credits does not affect the amount of benefits you receive.--So a minimum of 10 years is required to receive benefits. The amount of credits earned is used to determine eligibility for retirement or disability benefits, as well as family’s eligibility for survivors benefits. IN 2022, you must earn $6,040 to get the maximum four credits for the year.
- Social Security benefits are typically computed using "average indexed monthly earnings." This average summarizes up to 35 years of a worker's indexed earnings. This is a very confusing calculation, you don't need to worry about it, I just try to point out to some taxpayers, that the very low income they are reporting, while great for a low to no tax bill, may have a negative impact on their 'benefit calculation' down the road. I had several Uber/Lyft drivers, income reported by Uber $50-70K, the huge amount of mileage and fees charged brought their incomes down to basically nothing. I just warn them that Social Security isn't looking at the $50-70K in income, but rather the profit.
  - From Social Security: 'We base your retirement benefit on your highest 35 years of earnings and the age you start receiving benefits.'

From Keepertax.com an awesome Mileage Log -- in Google Sheets which can be converted to Excel (click image to open--then save a copy to your Google Drive)

Here is a multipage spreadsheet for tracking all income and expenses including mileage. You need to enter the correct mileage for the tax year. In Google Sheets which can be converted to Excel (click image to open--then save a copy to your Google Drive)

Mileage reimbursement covers: cost of gas, repairs, car insurance*, maintenance (tires, oil changes, wiper blades, car washes, brakes, etc.), and depreciation. VITA/TCE sites can only do business mileage reimbursement, not actual expenses.
*If client drives passengers (like Uber/Lyft) then ask if they reported that to their insurance company and their insurance rates went up because of that--most car insurance companies charge an extra fee for the coverage of transporting people. That extra required coverage CAN BE deducted as well as business mileage. Other than that, car insurance is not deductible as it is included as part of mileage reimbursement.

These are fabulous organizers for anyone that is Self-employed (General, Music, Rideshare Driver)

General Self-Employment Worksheet (click image to open)

Musician Performing Artist Worksheet (click image to open)

Rideshare Driver Worksheet (and tons of other resources below) (click image to open)

Mileage Tracker Log

Diagram-- Business vs Commuting Mileage (PUB 4012)

Terrific handout for doing Rideshare Driver Taxes

Ridesharetaxhelp.com
One resource you may find very helpful (and where the first two attachments below came from) is http://www.ridesharetaxhelp.com/ Ridesharetaxhelp was created by the Center on Budget and Policy Priorities, part of the Get It Back Campaign.

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Self Employed: Schedule C