Author: Jeri Ann

Our buddy, Peter, likes to collect comic books, comic-related paraphernalia, and card-based games. He makes a point to get special editions, plays with some packs but keeps other in original packaging. He buys and sells these items routinely.

 

Question:  Is Peter running a business?

Answer:  A solid “maybe”.

 

The Internal Revenue Service has rules about what is and isn’t a business and it’s important.  If your endeavor as a “side-hustle” is deemed a hobby, you cannot deduct what would normally be business expenses and could be taxed on proceeds arising from the activity, after the Tax Cuts and Jobs Act of 2017 suspended deductions for hobby expenses until 2025.

An underlying presumption is that people run businesses to make a profit. If you find yourself thinking “I really enjoy this activity and I just want it to pay for itself” or “If I don’t make a profit in any given year, then I won’t have to pay taxes” then you might have a problem.

There are three things to keep in mind that we’ll discuss in brief here: the safe-harbor provision, deferring determination of business or hobby, and the nine factors the IRS looks at. For further detail, you should consult the IRS (Publication 535, Business Expense is a good start) or your tax-preparer.

The “safe-harbor” for most businesses is that if you make a profit in at least three of the prior five tax years, you are assumed to make a profit. Why do we say “most businesses”? Because if you breed, train, show, or race horses, the time frame is at least two of the prior seven tax years.

(We here at Sunstone Bookkeeping love trivia … )

If you are a new business, you can file Form 5213 to postpone determination “ … Whether the Presumption Applies That an Activity is Engaged in for Profit” within three years of the due date of the return for the first year you start your activity.

The IRS looks at nine factors to determine if your activity is a business if you don’t meet the safe harbor requirements; no one factor alone is determinative. As the deductibility of the expenses are at jeopardy here, we are phrasing the factors in the form of a question:

• Do you carry on the activity in a businesslike manner? Have you registered the business as an entity or DBA? Do you have a written business plan?  Do you maintain financial records?  Peter should be keeping an inventory, tracking prices for items, finding venues frequented by buyers, etc.
• Are you putting in time and effort to make the business profitable? Spending material time on the activity (particularly if it does not have a “fun” aspect) and taking time away from another occupation are supportive of this factor. Also, hiring competent people to run the activity even if you do not personally spend a lot of time shows profit motive. Peter needs to do more than just buy comics and read them!
• Do you depend on the activity for your livelihood? If you are trying to pay the bills in part or in whole with this activity, then it is more likely to be a business in the eyes of the IRS than a hobby. Is Peter trying to make enough money here for more than buying another graphic novel?
• Did you lose money because of things you cannot control (or are normal at your stage of start-up)? This is pretty much self-explanatory but see the next question …
• Do you change your operating methods to improve profitability? If the business is not making money, you should do something about it if you want to be considered a business seeking to make a profit. Is Peter consistently buying niche items that he likes but aren’t popular for re-sale? If so, he needs to change his business practices.
• Do you have the expertise necessary to be successful? Remember, the relevant definition of successful here is “profitable”. You don’t necessarily have to know the industry in-and-out, but you should be able to show that you’re taking steps to improve your industry knowledge and apply standard business practices.
• Have you demonstrated an ability to be profitable in similar activities before? If you’re starting your first business, then obviously you’re not able to prove or disprove this ability. However, if you’ve tried and not succeeded multiple times, you might have a harder time defending your venture as a business.
• Has the activity made money in some years? See the above regarding safe harbor.
• Can you expect to make money from the appreciation of assets used in the activity? In Peter’s case, can he reasonably expect to make more money from the sales of his inventory if he holds on to it? Or will the value of the inventory decrease over time to the point where sales on eBay would create a loss as if he marketed them in a yard sale?

 

If you’ve taken this venture seriously, putting in time and effort (and legitimate funding) into making the venture profitable to pay your bills, you’re not likely to run afoul with the IRS.  However, if your venture is no more than a money-losing “side hustle”, you’ll have a hard time defending your expenses as deductible and will potentially have extra earnings on which you owe taxes.

For Tax Year 2020 (i.e. for tax forms you’ll file in 2021) what used to be on one form, the Form 1099-MISC, is now split between a slimmed down 1099-MISC and a “new” 1099-NEC. I say “new” because it last existed in 1982, so it is new to most of us.

Before getting into what you must report on each, let us first go over what DOESN’T get reported on either of the two forms:

• Payments to a corporation (C or S) or an LLC treated as a corporation (there’s an important exception regarding lawyers);
• Payments for merchandise, telegrams, telephone, freight, storage, and similar items,
• Rents paid to an agent or property manager (the agent or manager must report on 1099-MISC payments to the property owner);
• Employee wages;
• Group term-life insurance costs;
• Military differential wage payments;
• Business travel allowances;
• Payments made through a third-party network transaction (credit cards and other payment processors);
• And a few specialty cases.

What is this Form 1099-NEC?

Way back in 2015, Congress passed an act they called the Protecting Americans from Tax Hikes (PATH) Act which resurrected the Form 1099-NEC for reporting Non-Employee Compensation (see, “NEC”). If you run a trade or business (nonprofits and some special cases are included as well), what you reported on Line 7 of the 1099-MISC last year now has its own full form. Your deadline for the 1099-NEC is February 1, 2021.

In general, you will report on Form 1099-NEC any amounts in excess of $600 for: services performed by someone not your employee, payments to an attorney, or (yes, I’m serious here) cash purchases for fish from a fishmonger.

The most common items to report on your Form 1099-NEC include:

• Service fees and payments to independent contractors (examples include consultants, plumbers, bookkeepers, graphic designers, etc. who are not your employees);
• Fee-splitting or referral fees;
• Non-employee commissions;
• Payments to entertainers;
• Exchanges of services (yes, “barter” arrangements for services are captured here).

A very special case is that Attorney’s Fees paid in cash over $600 are reportable on your 1099-NEC even if paid to a corporate entity.

What about the old 1099-MISC?

Now, your old friend the 1099-MISC is still around with a fresh new slimmed-down look. You will need to file that by March 1, 2021, if you are filing on paper or March 31, 2021, if filing electronically.

The most common items you will report on your Form 1099-MISC include:

• Royalty payment in excess of $10;
• Rents paid to a property owner;
• Prizes and awards;
• Amounts of federal income tax under backup withholding rules (even if the person in question is not an employee);
• And some special cases, including deceased employee wages, payments made on behalf of another person, state or local sales taxes imposed on the seller of services but paid by you, fishing boat proceeds, payments in lieu of dividends or interest, crop insurance proceeds, and nonqualified deferred compensation.
• There is a “check the box” requirement if you made sales of $5,000 or more to a person on a buy-sell/deposit-commission/or other commission basis anywhere outside an established store (network marketers: take note).

And of course, payments to an attorney make an appearance for special treatment here: gross proceeds in excess of $600; that are paid in connection with legal services but not FOR the attorney’s services (for example an amount paid to a law firm as part of a settlement agreement); and are otherwise not reportable on the 1099 NEC are reportable on the 1099-MISC.

Another special case are payments of $600 or more to a physician or other provider of medical/healthcare services in the course of your trade or business, including corporations. But note the key words and ask yourself: Was this “in the course of my business” and not incidental?

Some questions to ask when determining if you need to file either of the 1099s:

First, ask yourself:  Is this payment to a living employee? If yes, then more likely than not, you’ll not report it on these forms. If you work through the W-2s you’ve filed and find there’s some payment to an individual that doesn’t belong there, then you might need to revisit the 1099s.

Second:  Did you pay by credit card? Then you can move on.

Third:  Was this payment in the course of operation of my trade or business? Personal payments are not reported here.

Fourth:  Did you pay a lot of cash out in any way related to purchasing fish or hiring attorneys?

Fifth:  Anything else a bit weird?

Those five questions will likely sort out most of your concerns and lead you to the right form. But as always, consult your tax preparer or tax attorney for specific questions or issues.

2020 has given us a spectacular amount of unexpected events.

But there’s one thing that we knew would happen:

TAXES

Yes, we got a delayed filing deadline (yay!).

But we still had to file them (*sigh*).

And for many business owners, because you’re so busy running a business, the annual gathering of the paperwork/receipts/statements/information/all things financial ends up happening waaaaay too close to that filing deadline.

Which means stress, and hurrying, and a higher chance of deductions getting missed or mistakes being made.

So … how about we make 2021 a little different?

Join me on Facebook for a FREE Five-Day Prepping for Tax Prep Challenge!

We’ll meet for five days online, where we’ll guide you on how to locate the relevant information for the different sections of the Schedule C and Form 1065.

The best parts?

1.  No calculator or bookkeeping knowledge required.  We’ll be showing you where to find the information needed to file the taxes, NOT filling out any of the forms.

2. The challenge starts on January 11, 2021, so there’s no work to do until after the holidays!  (But definitely feel free to introduce yourself and check out the activity there before we get started.)

So, if you want a tax filing season that’s less stressful than usual, click on over to the Facebook group and join us!

 

It’s a big hassle to get a business bank account without a lot of fees and minimum balance.  I just want to keep things simple and run my business through my personal checking account. 

 

*cue a loooong sigh and the loosening of shoulders before typing*

 

The number one recommendation I make to all business owners, regardless of industry, age of business, income levels, profit margins, and legal structure is this:

 

Always.  Have.  A.  Dedicated.  Business.  Bank.  Account. 

 

It is impossible to stress this point enough.  Seriously, I’d be willing to send everyone a text every day reminding them to open a dedicated account for the business if I thought it would work.

 

Here are a few reasons why having a dedicated business bank account is crucial:

 

1. As I mentioned in an earlier post, mixing personal and business funds can create issues with bookkeeping and taxes. Having a separate bank account dedicated to your business helps prevent these issues from happening.
2. Certain business structures require you to have a separate business account. The Internal Revenue Service requires that LLCs, partnerships and corporations must be taxed separately from the business owners so the accounts must be kept separate as well.
3. Even if your business structure doesn’t require it, you’ll feel a stronger sense of professionalism if you maintain a separate bank account for your business.
4. You’ll be able to build credibility for your business, which will help other businesses take you more seriously. A check from “Business Name” is more professional than a check from “Jane Doe”.
5. Banks often require a business account to apply for financing or loans.

 

By the way, it’s not just the checking account that should be separate from your personal accounts.  Your business should have its own credit cards and direct payment processors (such as Stripe or PayPal).

 

While it may be more convenient to have only one bank account to track, your business needs … no, it deserves its own dedicated bank account to grow and thrive.

 

Questions or comments?  Let us know below!

This is not a comfortable post topic, because I’m writing about the worst-case scenarios for my own profession.

 

Most bookkeepers are honest, knowledgeable, and hard-working.  But as in any industry, there are always the few proverbial “bad apples” out there.

 

If you decide to work with a bookkeeper, whether you hire an employee for bookkeeping or work with an outsourced bookkeeping firm, here are two statements that serve as glaring warning signs:

 

“I’ll need your login and passwords for the financial accounts.”

 

You should NEVER (and yes, that word requires all caps in bold and italics) share your personal access information for any financial or business accounts with anyone, including a bookkeeper.

 

You can authorize a separate user access for the bank accounts if the bookkeeper is responsible for paying bills.  If more than one person uses the same login and password, it will be difficult to determine responsibility if there’s any suspicious activity during a login session.

 

If the bookkeeper’s duties do not require access to business funds, then don’t provide it.  Instead, you can authorize the bank to set up a read-only access for the bookkeeper.  Read-only access allows the bookkeeper to view the online information and run specific reports without allowing access to the funds.

 

“You don’t need to access the accounting software – I’ll send you what you need when you ask for it.”

 

This is YOUR business, and you have a right to the financial information at any time.

 

You can avoid this problem by purchasing the accounting software or subscription and designating yourself as the master administrator, then creating a separate user account for the bookkeeper.  If you hire with an outsourced firm, you can provide the firm with an “Accountant Access” login.

 

However, if the outsourced firm pays for and manages the accounting software or subscription, you should require the firm to provide you with a full-access user account.

 

In short, prospective bookkeepers who utter either of these two statements should be avoided.  Run, don’t walk, away!

 

Questions or comments?  Let us know!