Tax Question

[pghmyn]

So I am still considering the idea of semi pro with just a few projects throughout the year to earn some extra income.

If I was to do something like this, and have the intention to sell for a profit, what can I write off? And, more importantly what does it mean to write something off for business purposes? What benefits do I achieve from this?

Thank you!

[Dlhunter]

Well it depends. You should really talk to an accountant.

In short whatever you buy for you business (tools, materials, ect..) you take off of all of the money you bring in from the business and get taxed on your profits. If you have a shop at your house you can deduct a percentage of the utilities equal to the percentage of sqft it takes up in your home. There are a lot of different scenarios though so you really need to talk to a professional. Depending on your state there are requirements like insurance, licensing and such you will need to look into as well.

[TRBaker]

Most of your stationary tools will not be allowed a complete write-off in the first year. You have to have your accountant put these on a depreciation schedule and you are only able to deduct that percentage each year. Darrel is right...ask an accountant. That will be a lot more accurate info than us just pooling our ignorance.

[CessnaPilotBarry]

Talk to an accountant... Tax decisions can be very situation dependent.

You don't have to depreciate machines over time, unless you're really spending a lot. The last time I looked, Section 179 (expensing) allowed some big numbers of one-shot depreciation, in the 1/2 a million range, but there are limits for specific things. Once upon a time, I did this all the time. because depreciating pro sound gear over 20-30 years is stupid. ;^)

The plus of depreciating over time is that you can save some tax in future years, especially if you don't have the income to write off now. A negative is more complex record keeping, including calculations around recaptured depreciation if you sell valuable business property down the road.

You're probably best off simply expensing supplies, operating expenses, and small items, and keeping your machinery "personal" property. A professional with access to ALL of the details of your situation can help you decide.

[dwacker]

Open a C corp in New Mexico, you personally finance the assets to the NM corp with interest, your WW corp leases the assets, NM corp depreciates, you file and hold the UCC, NM defaults on financing, UCC holder repo's, whole process starts over...... Simple

Don

[TRBaker]

Thanks, Don. BTW....are you a politician?

[jHop]

My regular job has a couple of NDA's (non disclosure agreements for those with more sense than me), but what I can tell you is that I work for a bank lockbox that processes, among other things, tax returns for localities. I may have mentioned too much already (fine print, you see), but I'll share what I know I can.

Talk to an accountant. Not just the H&R Block or Jackson Hewitt types, not some volunteer at tax time, go pay the big bucks for an accountant.

You have federal tax issues regarding depreciation and "corporate property" (since this might not be a corporation, different accounting rules apply for the various business types). You have state tax issues, which sometimes follow corporate and sometimes don't. And you have local tax rules that very rarely follow federal tax rules, but start with federal tax figures.

Everybody remembers to file federal (those that don't find uniformed types quickly enough offering a gentle reminder). Most remember to file the state returns, which may or may not offer a uniformed delivery service on the reminders. Not everybody remembers to file locals. And speaking from work experience, the "box returns" you might find in the stores, either software or those with the quick-print business cards, do not always know or remember to file local taxes. Plus, you may have to file multiple local taxes, depending on where your shop is and where your primary work is.

Here's a potential nightmare for you: your income from your day job, which you earn in municipality x, in county woodworkia, pays for your wood working business you run from your house, in municipality y, in county residentalia. This income is taxed in woodworkia /x at one rate, and residentalia / y at a second rate. Then, because it is used as capital for another business, it gets taxed in residentalia / y as both income and capital.

Get a professional involved. Save yourself some headaches. I get filings from people daily that never filed their local returns, because they were too complex, the software did not cover the filing (happened to me personally for two years), or they did not know they needed to file in multiple localities. Even in the same county, there may be two localities filed. Plus, the licensed individuals usually know more advice than us occasional types.

[jHop]

Some specifics:

[W]hat can I write off?

Pretty much anything used for business use and strictly business use can be written off, or a portion of it written off.

And, more importantly what does it mean to write something off for business purposes?

You are saying that this portion of your business expenditure was needed to effectively operate a business. This is done by offsetting the purchase of what I call "short term needed items" within the taxes. Again, I'm not a tax professional, so my terminology is simply what I call it to understand the process. What it can mean for you is that, if your business needs the large belt sander to efficiently and effectively batch out products, you can decrease your reportable income by a necessary expense. Tax individuals at all levels have specific lists of what, and how much, of a business purchase can be deducted from your income. Paying for fuel or tolls to a customer work site / delivery site (which might have it's own requirement of income tax filing) can be deducted; stopping at a fast food store for a beverage along the way might be deducted, deciding to pick up the latest bestselling teen novel while you are out there will not be allowed.

What benefits do I achieve from this?

Potential benefits include reducing your income below taxable limits. You still need to report it, but you might actually have lost enough money to get a portion of your tax return back. Also, potential benefits include enough of a refund from your business that they will pay for any expenses you might have on a personal side.

Depending on your state there are requirements like insurance, licensing and such you will need to look into as well.

You may not be able to deduct all of these expenses. You might only be able to deduct a percentage of each of them, as they might be viewed as something necessary to operating a business, but a certain percentage of them might be viewed as a taxable benefit. For example, if you get a business phone, it usually is a write off. However, if you get a business phone, and get a smart phone, and carry it with you and watch movies on it while you keep your personal phone free for calls, you will not be able to write it off.

It boils down to specifics that we do not have access to. If it is for business purposes first, foremost, and only, it can be deducted. Your mortgage can be partially deducted only if you specifically "carve out" a section to be used for the business and only for the business. If you convert your garage into your workshop, for example, parking your car in it at night can negate the deduction of your shop. If you run your Christmas lights from your shop power outlet, you might not be able to deduct utilities from your taxes.

You don't have to depreciate machines over time, unless you're really spending a lot. The last time I looked, Section 179 (expensing) allowed some big numbers of one-shot depreciation, in the 1/2 a million range, but there are limits for specific things. Once upon a time, I did this all the time. because depreciating pro sound gear over 20-30 years is stupid. ;^)

Again, I'm not a tax professional. Large expenditures in business can be written off in many different categories. From a manufacturing perspective, if the tool is required, you might only get a percentage unless the purchase price is over a specific amount. A tax professional can tell you whether it is or not.

The plus of depreciating over time is that you can save some tax in future years, especially if you don't have the income to write off now. A negative is more complex record keeping, including calculations around recaptured depreciation if you sell valuable business property down the road.

And if you decide to make something for yourself, not for a client (and yes, there are restrictions on calling yourself a client), you can completely erase a year's worth of deductions. Plus be required to pay back any deductions you have claimed on the item.

You're probably best off simply expensing supplies, operating expenses, and small items, and keeping your machinery "personal" property. A professional with access to ALL of the details of your situation can help you decide.

From what I know, and again I'm prevented by saying a lot by NDAs, if it is necessary to the operation of the business, an operating expense can be deducted. For a specific example can be a can of stain or finish - if a customer wanted a specific color. If you finish all of your projects (both personal and business) in shellac, for example, you can only write off the portion of the shellac you use for the business. Since this gets dicey, a tax professional will be able to say whether you can write off the entire can and simply "piggyback" personal usage because of the open container, or you might only be able to write off an 8 ounce portion of a 1 quart can. Buying a package of sandpaper, and noting on the client work order sheet the expenditure of "8 hours sanding, five sheets 200 grit, 8 sheets, 120 grit, 3 sheets 600 grit" might be the detail needed to pay for all the sandpaper.

A tax professional can tell you all the finer points. (and they may be able to turn this scary perspective into a real money maker. Don't be frightened by all the things I've mentioned.)

[dwacker]

Thanks, Don. BTW....are you a politician?

Just being a wise a&%. Depreciation is actually very simple and as a sole proprietor you dont need to complicate things even something as simple as turbo tax and quickbooks will do a fine job.

My real advice is to not mix business with pleasure when it comes to tax. The tools dont belong to the business they belong to you for hobby use. Mix the two and you open the door for a world of hurt if something goes wrong. Unless were talking many thousands of dollars it just not worth the heartache. When we start talking about real money then its time to incorporate and see a tax lawyer.

Don

[CessnaPilotBarry]

"A tax professional can tell you all the finer points. (and they may be able to turn this scary perspective into a real money maker. Don't be frightened by all the things I've mentioned.) "

Exactly... My first 1984 musician bookkeeping system was a $5 ledger pad. I think I used three pages a year in the first few years. Want to see how audits work? Write "musician" or "entertainment technician" on your tax form, then claim everything you're entitled to claim. I went through 2 mail audits, and an in-person audit with flying colors.

In many cases, it doesn't need to be more complicated than a ledger pad, but nowadays Excel can replace the paper, and Quickbooks can replace EVERYTHING, much easier...

Any good tax pro can give you a Quickbooks template, and a list of what documents you need to keep, right off the bat. If most hobby woodworkers truly calculated supplies and expenses, the actual taxable income would be far less than they might have guessed. There also ways to continue as a hobbyist, paying taxes on income and deducting related expenses, without actually turning your tools, equipment, or space, into business property.

[dwacker]

There also ways to continue as a hobbyist, paying taxes on income and deducting related expenses, without actually turning your tools, equipment, or space, into business property.

When you run as a sole proprietor there is no business property as far as the feds are concerned there is no business in a sense it just you producing an income. You are the business, you cant sell yourself if you die the business is dead. Tools are nothing more than personal property used to produce an income. Anything used to produce that income can potentially be a tax deduction. Your state entity is how you go about deciding how to do your tax returns.

You DO NOT want to deal with an accountant. You want a tax lawyer! The lawyer will help you decide how to protect you in event of a problem, accountants are not qualified to determine the proper entity type for your life style. 99% of all accountants will tell you S corp and hype double taxation Bullshi*. What they dont tell you or may not know the minute you co mingle a single dime you are no more protected than a sole proprietor and wasted your time and money paying the accountant to set you up as an S corp. So many folks jump on the S corp or LLC bandwagon on the advice of an accountant and get burned do to circumstances beyond their control.

I would never suggest you run as a sole proprietor and doubt any lawyer would either. If you want to skip the lawyers and accountants. If you want to start off small without jumping through all the hoops of establishing an entity be it sole proprietor or corporate the simple answer is a buffer. Be a hobbiest as far as the feds are concerned, deduct your actual expenses, skip depreciation and find a buffer! !!!! A buffer can be a consignment shop, a contractor in the case of cabinet or millwork, a gallery and im sure there are plenty more options.

In most states there is a limit WA is 12K. I could sell 12K worth of cabinets to a design center with no license, collect no sales tax, run no real books and still deduct all my wood, supplies and maintenance like sharpening. I can even deduct small tools like cutters and saw blades without ever being a "business" as long as I report the income to the feds. The state could care less until you sell retail, hire employees or go over 12K. To be honest as long as I have a buffer I could go 100K and the state could really care less because there is nothing in it for them. NO a buffer is NOT cheating. Your still paying taxes and reporting income. The state gets their cut from the buffer and you have no responsibility to them what so ever. You get your tax deductions and everyone is happy happy happy.

Don

[Chris H]

One thing that hasn't been mentioned (or I missed) was that your book keeping and ability to expense items will very widley on how your business is registered. Sole Proprietor, LLC, Corp, etc.

If your business is not yet registered, get that done. It's a nominal fee (mine was $25), at the county register of deeds.

Again, it's been said, but talk to an accountant/lawyer. Some may be willing to sit down and talk for little or no fee in hopes of snagging your business down the road.

One thing that I find shocks or suprises most new small business owners is the sheer paperwork needed to track expenses and revenues for tax purposes. You need every receipt from home depot, and either paper or electronic documentation for every sale.

[jHop]

Most people think of that scene from Dodgeball when the closet containing the records is opened. That's the mental image that is most common when someone says "keep all your records."

If you are serious about going into business for yourself, you need to remember to add some form of record storage into your plan for shop space. The good news is that it can be as simple as adding a scanner and memory: last I heard (remember, I'm not a tax professional), the tax revenue departments will accept scanned copies of documents for proof. (Plus, this way you can keep that Home Depot or Lowe's receipt fresh, since they seem to use the fast-deteriorating thermal paper on virtually every receipt I've received.)

One thing I personally have done, although I have not started to file taxes for business purposes, is to take a photo of the item still in the package, from four main angles. I try to get a clear image of the bar code of the package, the frontal shot that contains the overall image along with manufacturer, size, and price (if available), and one close up shot of the serial numbers. I have each of these photos stored in a folder on the hard drive with a copy (photo or scanned) of the receipt showing the date of purchase. This is useful both for taxes and insurance purposes. (Came in handy on some repairs for a dryer that I purchased for my father in law, which I did not have to pay for thanks to the records I kept.)

[dwacker]

One thing that hasn't been mentioned (or I missed) was that your book keeping and ability to expense items will very widley on how your business is registered. Sole Proprietor, LLC, Corp, etc.

If your business is not yet registered, get that done. It's a nominal fee (mine was $25), at the county register of deeds.

Again, it's been said, but talk to an accountant/lawyer. Some may be willing to sit down and talk for little or no fee in hopes of snagging your business down the road.

One thing that I find shocks or suprises most new small business owners is the sheer paperwork needed to track expenses and revenues for tax purposes. You need every receipt from home depot, and either paper or electronic documentation for every sale.

Not really. Corps and Proprietors get to write off all things equally. Your entity has nothing to do with it. Your entity only changes the when and how, meaning yearly or quarterly. Your LLC or S corp is going to pass through your 1040 with a schedule C just like a sole proprietor. Your C corp is going to file 1120's

As mentioned there is no need for paper what so ever. Electronic filing with a good indexing system is the key. The system must be indexed for quick by the document access. An invoice reference number can be used as a pdf file name, indexed in the memo or reference line of your accounting software like quickbooks. I havent kept a paper receipt for years.

Don