What is my Tax Reporting Status as a Mary Kay Consultant?

Transcription

1 Our Mission Our goal as a CPA firm is to provide quality tax compliance and financial assurance services to the general public, as all CPA firms do. However, our top priority is to communicate and educate our client base so that they remain well informed and can make the proper decisions with regards to tax and financial planning. The following is part of our educational commitment to that goal. Many areas of this article come from the publication provided by Mary Kay titled Tax Essentials A Guide to Your Mary Kay Business Taxes. Our goal is not to explain every item of tax law and form instructions, but provide a short and general guide to understanding the tax compliance issues involved. What is my Tax Reporting Status as a Mary Kay Consultant? Your tax reporting status with Mary Kay is not unique to Mary Kay. Most outside salespersons are treated as Independent Contractors, or a Self-Employed individual. We will refer to you as a self-employed individual. Self-employed individuals are treated differently than W-2 employees. The biggest issue involved in being self-employed is self-employment taxes and deductible expenses. However, one key IRS issue to be aware of is the Hobby Loss rule. If your Mary Kay venture does not report a profit in three out of five consecutive tax years, and you used losses to offset other income, the IRS may make the determination you were not engaged in this to make profit and this was merely a Hobby. They may then limit the deductions to offset the Mary Kay income you made, require amended returns from you, and assess penalties and interest for the proper reporting of your taxes. What Mary Kay Income Do I Report? You must report all your product sales, commissions, prizes and awards. All this income is subject to tax, whether received by check, credit card, cash or even barter (exchange of Mary Kay product for tax prep fees). You should receive a Form 1099MISC from Mary Kay providing you this level of detail, however, be sure to check your own records to verify the accuracy of these amounts reported by Mary Kay and make certain that you do not under-report your income. You will receive a 1099MISC only if your total income exceeds $600. However, simply because you don t receive this form does not mean you don t have to report the income. Most of your income will be highlighted on the Income Advisory Statement. Sources of Mary Kay income may include: Personal sales (skin care classes, facials, and private makeover sessions). Reorders and the Preferred Customer Programs. Recruiter and Sales Director commissions and bonuses. Tax and the Mary Kay Consultant Page 1 of 10

2 Company awards, incentives and prizes. This includes the use of a Mary Kay car. Embrace gift service sales Dovetailing. Car program. Sales Director Term Life Insurance Award. For income tax return purposes all the above is reported as income. There is no need to list each individually on the return or a separate schedule. What Taxes are Assessed to me as a Mary Kay Consultant? Your main concern as a Mary Kay consultant is self-employment tax, in addition to your regular income tax. This self-employment tax provides Social Security and Medicare benefits for you upon attaining the eligible age for benefits. Self-employment tax is 15.3%. Remember your last paycheck when your employer took out Social Security and Medicare taxes from your paycheck, well that was a total of 7.65% and the employer paid the other half, or a total of 15.3%. Well, congratulations you are now the employer so you get to pay the full amount, except you can deduct many expenses before this tax is computed. The income you receive, less the deductions you incur produces net selfemployment income. Example, $10,000 income less $2,500 deductions creates net selfemployment income of $7,500. You will pay regular tax and self-employment tax on this $7,500. When & How do I Pay the Taxes? Here is where we caution all of our self-employed clients. Because you are not an employee of Mary Kay, you are responsible for retaining and submitting your taxes to the IRS. You are not exempt from self-employment taxes! Failure to pay in these taxes on a quarterly estimated basis (April 15, June 15, October 15, January 15 with Voucher Form 1040ES) will subject you not only to the tax, but penalties and interest as well. Also, remember that Mary Kay sends a copy of the 1099MISC discussed above to the IRS, so they know how much income you are to report. You must pay in quarterly the smaller of 100% of your prior year s tax liability, or 90% of your current year s tax liability to avoid yet another penalty for underpayment. How do I Report the Income and Expenses? You must report your income and expenses annually on Form 1040 and use the following additional forms/ schedules: Form 1040 (Schedule C) Profit or Loss from Business (Sole Proprietorship) Form 1040 SE Self-Employment Tax Form 4562 Depreciation and Amortization Tax and the Mary Kay Consultant Page 2 of 10

3 Form 8829 Expenses for the Business Use of Your Home When is the Return Due? The Form 1040 U.S. Individual Income Tax Return, is due by April 15 th, unless the 15 th falls on a weekend or federal holiday. If more time is needed, you can file an automatic extension of time on April 15th, with Form 4868 Automatic Extension of Time to File U.S. Individual Income Tax Return up to August 15 th. This is not an extension of time to pay any additional taxes due, over what you have already paid in the form of estimated quarterly taxes. You may also file one last extension on August 15 th with Form 2688 Application for Additional Time to File U.S. Individual Income Tax Return, which must be approved by the IRS. Under no circumstances, should you file a return after October 15 th. After that date, the return is delinquent and will be assessed further penalties and interest. The Mary Kay Guide Refers to the Modified Accrual Method, what does this mean? A complex term, which merely means that income is reported only when received and deductions allowed only when paid. However, the existence of inventory and depreciation requires a slight modification of the method because even though you paid cash for inventory you cannot deduct its cost until it has a corresponding sale or you dispose of the inventory. You are allowed depreciation on an asset even if you financed it and no cash was disbursed during the year. Tip - expenses charged on a credit card on December 31 st 2002, but not paid until the January 31 st statement are deductible on the 2002 tax return. This will allow you a year-end deduction, allow you to earn 30 more day s interest, and build card member benefits. What s so Special About Sales Taxes & Non-Recovered Sales Tax? When product is purchased through Mary Kay the sales tax on the cost value is paid at that time. When you sell your product, you collect the sales tax on the market value. You are required to remit to Mary Kay the excess amount of additional tax collected over what was prepaid. Mary Kay then handles all the sales tax reporting and payment remittance to the State Comptroller on your behalf, relieving you of this administrative burden. However, when you prepay these taxes and later gift, donate, or dispose of the product you have lost the sales tax you have paid, this is called Non-Recovered Sales Tax and is a deduction for you. Tax and the Mary Kay Consultant Page 3 of 10

4 What s so Special About Inventory? Inventory is not a deduction! Inventory represents the cost of the Section I & II products you have on hand. Inventory is a detriment to all businesses, because it represents tied up cash flow and profit. You should try to keep as little inventory on hand as possible at all times and especially at year-end. If you have any inventory on hand, count it and then determine what your cost was in the product. Do not value the product at its suggested market value! Also according to the Mary Kay guide, the year-end summary report only reports Section I and II purchases from January through November, you must account for the December purchases. What Should I do if I have too Much Inventory at Year End? Your goal is to report as much expense as possible by year-end to minimize your taxes. Ever notice those inventory reduction sales of auto s, or furniture where everything must go! The effect on income, franchise and property taxes are the main reason businesses reduce their inventories. Be creative; throw a year-end party, give bonus gifts to high volume customers, send an arrangement to women executives, etc. But sell your inventory at cost if need be to reduce your count. You can always repurchase more on January 1 st. But remember count your inventory at year-end! Do I Get to Deduct any Inventory I Give Away or Use for Myself? You are allowed to deduct the cost of any item held in inventory that is for a legitimate business purpose. This includes charitable contributions and promotions. Part of any successful selling career is providing gifts to special customers or referral sources. A product arrangement valued at $25 or less is fully deductible. Any item you use for personal purposes is not deductible. Inventory you receive for free should not be counted at year-end, because you incurred no costs and when you sell it, you will make 100% profit. What is Depreciation? Depreciation is the method of allocating costs of assets over the asset s average life. The IRS provides guidelines as to the lives of certain assets. However, be aware that a special provision exists that allows you to write-off the cost of certain assets in the year acquired, giving you a very large tax deduction of up to $24,000. What Auto Expenses Can I Deduct? Tax and the Mary Kay Consultant Page 4 of 10

5 To answer this question, you must first understand the IRS substantiation guidelines. The rules state a taxpayer must provide some sort of proof of the business use of the auto and then you may deduct a percentage of the actual business use. Note you must substantiate the business use of your auto by maintaining a log of total miles driven and miles driven for business. A simple log book (Dome #750 Auto Mileage Log or a Computer Record) will suffice as long as beginning day odometer and ending day odometer and the business miles are represented. Mileage from your home to your clients is considered business mileage. Next there is also some confusion as to the meaning of Passenger Auto. Some believe a vehicle weighing over 6,000 pounds is not subject to the limitations on auto depreciation deduction. The regulations state that in general, a passenger automobile is any four-wheeled vehicle manufactured primarily for use on public streets, roads, and highways, and that is rated as having 6,000 pounds or less of unloaded gross vehicle weight (or, in the case of trucks and vans, "gross vehicle weight"). Some people buy fully loaded Ford Excursion or Chevy Suburban to deduct the full cost of the vehicle. Be very careful in doing so, the IRS is gearing for more audits. For years 2001 through 2004, a special law was passed in early 2002 providing for 30% more depreciation in the first year of the acquisition of a new auto. If you bought an auto after September 11, 2001 and before September 11, 2004 you can take advantage of the larger deduction. Now might be the time to consider the purchase of a new vehicle, since many auto manufacturers are offering 0% financing, as well as taking a larger tax deduction. Note if you did purchase a new vehicle in 2001, you must weigh the cost/benefit of amending the 2001 return to take advantage of the larger deduction. The deductions associated with using your auto in the Mary Kay business are: Cost of Auto Depreciable over 5 years Garage Rentals Gas Insurance License Fees Loss on Sale of Auto (you must also report any gain on the sale of the auto used for business) Oil and Lubrication Parking Repairs Tires Temporary Car Rental Washing Note if you have earned the use of a Mary Kay car, the value of that auto is reported to you as income in the category of Prizes and Awards. Mary Kay will directly pay for the Tax and the Mary Kay Consultant Page 5 of 10

6 lease of that auto. Even though you did not disburse funds for that auto lease, the deduction is available to you because you also had to report the use as income. What Other Typical Deductions are Associated with Being a Mary Kay Consultant? The following listing will assist you in determining which expenses you incur will be deductible to offset your self-employment income. Some expenses however, do not reduce self-employment tax just ordinary taxable income. Accounting Fees if you hire an accountant to keep your records, 100% of the expense is deductible. A portion of the tax prep fee can be allocated to Schedule C and the rest to other schedules on the return, namely Schedule A. Advertising any costs you incur advertising Mary Kay products and yourself as a Consultant are 100% deductible. This may include sales literature, greeting cards, newspaper ads, inventory given away in promotions, and cost of your Preferred Customer Program. Attorney s Fees hopefully never needed, but if incurred you can deduct 100%. Bad Debts if you have a client who submits a bad check and you cannot recover it, this is a bad debt. Also, if you do not collect the cost of the product and the sales tax owed is also a bad debts Bank Service Charges establish a separate account so that if you incur any bank charges, it will be 100% deductible. Business Conventions Domestic (Fully Deductible), cruise (Limited), and foreign (Limited) Business Meals deductible but limited to 50%. Charitable Contributions Limited, but are considered an itemized deduction and will not reduce self-employment income. Commissions 100% deductible, refer to your Mary Kay tax guide as this is referred to as Dovetailing. However, you might also pay a commission for referrals and this meets this expense category. Computer Software depreciable over 3 years using the straight-line method. Contributions to Profit Sharing Plan limited to the lesser of 25% of net selfemployment income or $40,000. GREAT TAX-PLANNING TOOL you can establish the plan; take the deduction but fund (deposit the money) as late as the Tax and the Mary Kay Consultant Page 6 of 10

7 filing of the tax return. There are different types of plans to consider, consult your tax professional to determine which one best suits your situation. Note this is an adjustment to ordinary income, not self-employment income. However, this is the only deductible item in the tax code that generates a tax deduction and develops wealth at the same time, take advantage of it. New with now self-employed individuals can establish a plan loan program, which will allow you to borrow tax-free from your retirement account as long as you repay the plan. You will have to repay with interest, but the interest will go right back into your own balance for retirement. Consider using this as part of your financial plan. For example, if you put away a portion of your Mary Kay profit into your plan, you might have enough to fund your children s college education, have your children pay you back, and eventually your children will inherit their own college education money back. Dues Deductible, except to clubs organized for business pleasure, recreation or social, those are non-deductible. Employment Taxes fully deductible for any employees you have. Your selfemployment tax is an adjustment to ordinary income equal to ½ paid, but will not reduce self-employment income. Entertainment deductible only to 50% of the amount paid. Equipment, Furnishings and Fixtures depreciable over the life of the asset, determined by IRS regulations and depreciation tables under MACRS (Modified Accelerated Cost Recovery System). Gifts deductible to $25, per person, per year. Health Insurance partially deductible up to 60% for 2001 (70% in 2002 and 100% thereafter), but as an adjustment to ordinary taxable income, not against self-employment income. Other Insurance might include product protection and general liability insurance. You cannot deduct insurance of a personal nature such as long-tem care, disability, etc. Interest Expense you can deduct interest paid on a bank loan or credit card if the nature of the use of the account is for business only. Postage & Freight 100% deductible. Publications 100% deductible. Tax and the Mary Kay Consultant Page 7 of 10

8 Rent office, equipment, post office and safe deposit boxes. Repairs if for business equipment, then 100%. If in conjunction with a home office, see discussion below. Salaries and Wages do not pay yourself a salary, only your employees. Selfemployed individuals take draws for their living expenses, not salaries. Be careful to consider if you want to hire employees. Your legal risk and liability increase, as will payroll taxes. Many Mary Kay consultants may also want to hire an employee and treat them as contract laborers to avoid payroll taxes. Be certain to have this employee sign an independent contractors agreement to cover yourself for later unemployment and payroll tax claims that may arise in disputes. Supplies Supplies used for the office portion are included as a category called Office Expense. Sales aids are reported on a separate line called Supplies. Publications 100% deductible, if of a business nature, otherwise nondeductible. Telephone & Cell Phones - if exclusively used for business then 00% deductible. See discussion below for telephone used in the home. Travel Expenses hotel lodging, car rental, parking, airport tips, etc. (keep separate from meals and entertainment). You can deduct actual expenses or deduct an established amount provided by the federal government called CONUS rates, or simply put a per diem. Our website for a link to the CONUS website. What are Home Office Expenses? Because Mary Kay consultants have no actual office in which to store inventory, maintain customer records and perform their bookkeeping, the regulations allow you to deduct a portion of certain home expenses. Many people hear and believe that this deduction is too risky and don t seek it. This may have been the case before 1998, but the Tax Relief Act of 1997 amended code section 280A and added 280A(c)(1) that specifically provides relief for those who have no other place to conduct the administrative portion of their business. Home office deductions are allowed on the allocable portion used in the home, this may be a % of the square footage used or a % derived of the number of rooms used in relation to total rooms. However, when reviewing Form 8829, you will notice that it specifically requests square footage. There are limitations to the amount you may claim as home office deductions. The use of these deductions can only reduce self- Tax and the Mary Kay Consultant Page 8 of 10

9 employment income to zero; it cannot create a net operating loss. Any unused portion is carried over the subsequent years. First there are direct expenses that at 100% deductible and then those that are only allowed a % of the use. The list of expenses include: Home mortgage interest the remaining percentage is carried over to schedule A as an itemized deduction. Home Real Estate Taxes - the remaining percentage is carried over to schedule A as an itemized deduction. Repairs this includes interior and exterior, plumbing, painting, electrical work, etc. If the expense is in direct relation to the room, then it is considered a direct 100% expense. Depreciation you are allowed this deduction, but when you sell the home at a profit you must report the % of the business use as capital gains. Insurance an indirect expense, you are allowed the applicable percent. Utilities - an indirect expense, you are allowed the applicable percent. Security System - an indirect expense, you are allowed the applicable percent. Telephone - an indirect expense, allowed the applicable percent, if used by others in the family. A telephone used exclusively for the business is reported on Schedule C. Others although not specifically outlined in the regulations or in tax court cases, one would be able to claim the percentage use for maid services, carpet cleaning, etc. as long as the expense was for the entire home. Other expense would include casualty losses from fire, tornado, flood, vandalism, etc. Non Deductible Expenses lawn services, swimming pools, hot tubs and other expenses not needed for the conduct of a business are not included in the classification of home office expenses. What is the Best Method to Track all of my Income and Expenses? We are biased, the use of computer software, provides us an easily understood report. We suggest using inexpensive software for personal finance Quicken from Intuit, or true business software QuickBooks also from Intuit. However, simple ledger paper, MS Excel worksheets or Dome and other record-keeping aides will suffice. Tax and the Mary Kay Consultant Page 9 of 10

10 The Role of the CPA and Our Firm There is a maze of tax, audit, financial planning and risk management issues confronting any business owner and Mary Kay consultants are no exception. There are issues to consider each year as legislation is changed or amended. Your CPA keeps abreast of these issues and should provide as apart of his/her service communications to help you make the proper decision. We suggest that our clients plan on a tax-planning conference before year-end to prevent off a potential financial hardship. Tax planning is a key component of the financial planning process, a service that we also suggest our clients to review. In our experience, too many self-employed individuals do not set aside and pay in the proper amount of taxes and find the year-end taxes due devastating. Our firm provides a wide array of services ranging from record-keeping, payroll preparation, financial statement reporting, tax preparation, tax planning, retirement planning and administration, financial planning, risk management consulting and other personalized services to meet the need and budget of almost any client. We want to know each client individually so that we can propose through an engagement letter a series of services to meet your specific needs. We provide unique services including an Internet based self-preparation tool for $ We also offer an Internet based tax organizer that you can input your data; we can download the file and finish preparing your return. We can send your entire tax return to your in PDF format for you to review before coming to our office. We can also provide tax return review if you want to do-it-yourself but want an opinion before signing and mailing. Our services are expanding to offer complete financial planning services and investment counseling and trading. Our growth is predicated on excellent client service and referrals. As an appreciation for referrals, we provide a 10% annual recurring commission on accounting and tax fees. Our commitment is to you, our current or prospective client. This is why we produce many articles and free speaking engagements. Check our website at for other free articles, links and information. CALL US, WE ARE HERE TO SERVE YOU Tax and the Mary Kay Consultant Page 10 of 10