Tag Archives: filing taxes for the self employed

Uber, Lyft and Filing Your Income Taxes

We’ve all been there.  The thought of being  your own boss and leaving the 9-to-5, Monday-through-Friday grind to someone else.  Some of us take that jump and for others, the confines of a nice cubicle and a predictable  deposit into their bank account are more than enough.  But what if you are thinking of striking out on your own and joining one of those ride share companies?  Well, we strongly urge you to read this post as it has a LOT of information in it for you to consider before you take the plunge.

Worker Status
The first thing to know is that when you work for Uber or Lyft, you are not doing so as an “employee.”  Instead, you will be classified as an independent contractor.  As presented on Uber’s website:

“All Uber partners are independent contractors, so we do not withhold any taxes and partners are entirely responsible for their own tax obligations.  If you’re a partner based in the United States, you will receive a 1099-K and/or 1099-MISC form to report income you earned with Uber. You’ll receive one or both depending on the type of payment you earned in the calendar year.”

In this post we discuss the implications of being paid as an independent contractor versus an employee.  The big difference comes down to the fact that as an independent contractor 1) no taxes are taken out of the pay received and 2) the fact that the individual has to pay self-employment taxes in addition to income taxes.

Tax Considerations
In this post we talk about how those who are “self-employed” typically file their taxes and some of the issues they face.  What we’ll now discuss are those items specific to “drivers for hire” like taxi, livery and ride share operators.

Income  This one is pretty straightforward.  You report all of the money that you received while operating, including tip income.  Where we see people get into trouble is when they under report.  What do we mean?  Well, the IRS is going to get a copy of that 1099-K or 1099-MISC that you received.  If you report at least the amount that is shown on the document then you probably won’t hear anything from the IRS.  But if you report an amount that is LESS than what is shown, expect the IRS to come a knocking.  Why?  Well the IRS is going to ask you ” why did you only report $4,000 of income but Uber says you made $8,000?  We think you made at least that much but your return doesn’t reflect that.”

Now what if you say “I didn’t get a form so the IRS doesn’t know what I made!”  Can we say tax evasion?  So make sure you report every red cent that you made to stay out of trouble okay?

Operating Expenses  This one is the complicated one.  A taxpayer who uses an automobile for business purposes can figure their deduction by comparing the standard mileage rate with actual expenses and choosing the larger amount.  One would perform this analysis in every year and take the larger amount.  However, if the actual expense method is chosen in the first year, it must be used in all subsequent years until the vehicle is no longer used for business.

If the standard mileage rate method is used, the deduction is calculated by multiplying the number of business miles driven by the applicable standard mileage rate. The standard mileage rate eliminates the need to keep track of actual costs.   It is used to replace the “actual” cost of depreciation, lease payments, maintenance and repairs, gasoline, oil, insurance, and vehicle registration fees.   It does not include:

  1. Interest expense for a self-employed individual
  2. Personal property taxes
  3. Parking fees and tolls

The expense above would (depending on the circumstances) be claimed in addition to the amount calculated via the standard mileage rate.  Now, sometimes people (and tax practitioners) wonder if a “driver for hire” can use the standard mileage rate. Well back in 2010, the IRS issued Rev Proc 2010-51 and within it you can find that Rev Proc 2009-54 was modified as follows:

“Section 4.05(1) is modified to allow taxpayers to use the business standard mileage rate to calculate the amount of deductions for automobiles used for hire, such as taxicabs.”

You can also find language under the standard mileage discussion of Publication 463 that reads that “you can elect to use the standard mileage rate if you used a car for hire (such as a taxi) unless the standard mileage rate is otherwise not allowed, as discussed above.”

Now, If you decide to base your deduction on your actual expenses, note that you should keep track of the following:

  • Business Percentage: The taxpayer must calculate the business percentage of vehicle expenses. Keep track of business miles driven for the year and divide that amount by the total miles driven for the year.
  • Cost of depreciation (leave this to your tax software or gal/guy)
  • Lease payments
  • Registration fees
  • Licenses
  • Gas
  • Oil
  • Insurance
  • Repairs
  • Tires
  • Garage rent
  • Tolls
  • Parking fees
  • Sales tax paid on the purchase of a car is added to the basis of the car and deducted through depreciation.
  • Fines for traffic violations are never deductible, even if incurred while driving for business.

Business Expenses  This is for all of the items that aren’t directly related to the cost of vehicle operations, but are allowed.  Buy bottles of water for your riders?  Have to pay a monthly cell phone bill so that riders can hail you?  Both are deductible expenses.  We suggest that you consult Publication 535 to see what is allowed.  The one thing to keep in mind is that if an item is used for both business and personal use, you should keep track of your business use as that is the percentage of the expense that you may deduct.

Comprehensive Example & Sample Tax Return
If you click this link, you will be able to download the sample tax return that is used in this example.  Having it handy will help you quickly follow along with what we’re about to discuss. Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.  Okay, the lawyers are happy now.  Shall we begin?

Need a Lyft?

Need a Lyft?

So, our good friend Memphis Raines has decided to earn some extra cash with one of the ride share companies.  He’s pretty good at what he does, get’s passengers to their place really fast and makes sure that he keeps and IRS Compliant Mileage Log (he doesn’t want the tax court disallowing his deduction).  During the year he raked in close to $63,000 in income for all that driving.  So what does Memphis’ tax return look like?  Let’s examine it.

Page 3 shows Mr. Raines’ Schedule C or Profit or Loss From Business.  He completes the top section listing all the pertinent information for his business.  If you look at the form, you will see that it contains very little information.  Looks like he spent close to $16,000 on car expense, another $143 on meals (drinks for his passengers) and another $2,000 for his business cell phone.  But let’s look a little closer at the car expense.

As indicated above, Memphis is allowed to take the larger of his actual expenses OR the amount calculated by using the standard mileage rate.  If you look at page 6, you can see all of the expense that Memphis spent to make that $63,000 in revenue.  But the thing to note is that he used his car 80.4% for business. The rest of those miles?  Well, let’s just say they were spent with his kid brother Kip and some girl named Sway!  Anyway, looks like he spent $13,000 (ignoring the fact depreciation isn’t a cash expense) to make all that money.  It also looks like he drove about 27,000 miles in a year – ouch!  So if you take the standard mileage deduction ($0.56 in 2014) and multiply in by the business mileage, you get a deduction of around $15,000.  Since that is larger than the actual expense deduction of $13,000, which do you think he will take?

Was it worth it?
So Memphis had fun driving around all year.  But was it worth it?  Only he knows the answer to that, but what we can analyze is the financial impact.  Page 1 shows that Memphis had a net profit from business of around $45,000 (i.e. $63,000 in revenue less $18,000 in expenses).  As Mr. Raines is single, he has very little other deductions.  He takes the standard deduction and receives one exemption.  This leaves him with taxable income of around $32,000.  On this income, he has to pay $4,335 in income taxes.  But wait, Memphis is his own boss right?  Well, that means that he has to pick up the share of Social Security and Medicare taxes that an employer usually has to pay for each employee it has.  The bill?  Another $6,400 in taxes!  So Memphis winds up with a whopping tax bill of around $11,000.  As he did not make estimated tax payments he’ll need to come up with a way to pay the IRS.

So in looking at this from another angle, Memphis took in $63,000.  He spent another $11,000 in real cash to make all that money.  He also has to pay the IRS around $11,000 in taxes.  So net, he took home around $41,000 when it’s all said and done.  Not bad for being your own boss.  But he did put about 27,000 miles on that sweet car of his, which will make selling it harder once it’s days as a ride share vehicle are done and it’s just hanging out in videos by The Cult.

Well, if all of this sounds like way too much to handle on your own and you’d rather let a professional deal with it, why not give us a call or shoot us an email?  We’d be happy to help make sure that you stay on Uncle Sam’s good side!

Spending to Save Taxes vs. Generate Revenue

A few weeks ago we were speaking to one of our business clients about their tax planning needs for the upcoming year.  During this session, we got to talking about how spending money yields a “tax rate” reduction of one’s taxes for every dollar they spend.  This then prompted the analysis of spending to save on taxes versus to generate revenue.  Let us elaborate.

How Income Taxes Work.  A while back, we wrote about how the income tax system works with regards to refunds and balances due in this post.  The short version is that for each $1 you earn, you have to pay an associated amount of taxes based on your marginal tax bracket.  Conversely, for each $1 you spend on a deductible expense, it reduces your associated taxes by the tax rate applicable to your highest marginal tax bracket.

Spending To Save On Taxes.  One of the things we always try to convey to clients is to spend money on what makes financial, life or business sense.  Don’t spend money to save on taxes; if you receive an associated tax benefit, that’s just icing on the cake.  Why?  Let us illustrate.

Let’s say that Ricky lives in his mothers basement.  She doesn’t charge him any rent, but he gets this “idea” of buying a house so he can get a tax deduction.  So he goes and gets a mortgage and spends $10,000 on mortgage interest, which is tax deductible.  To keep things simple, we’ll assume that all of the mortgage interest is reflected on his return and that his last marginal tax bracket is 25%.  Based on this, he can expect to see his tax liability drop by $2,500.  But let’s look at it another way…

Ricky wasn’t paying anything to live in the basement.  Zero, zip, zilch!  But to get a $2,500 tax deduction, he went out and spent $10,000 on mortgage interest?  In the world of Finance we go by two rules:

  1. Cash now is better than cash later – due to inflation $1 today is worth more than $1 in the future so give me the money NOW!
  2. You only “save” money when you spend $0 – spending money is just that, an expenditure (no matter how big of a discount; sorry discount shoppers).

Using these two rules, it’s pretty clear that Ricky is in violation of the second.

Spending to Generate Revenue.  Thus, if you are faced with a decision to spend money, we usually recommend that you do so to generate more revenue (especially if you are in business).  Why?  There are numerous reasons but some include:

  1. You won’t see as big of a tax reduction as you would hope for by spending it on deductible expenses (see the example above).
  2. Increased revenue will allow you to spend on more beneficial expenses (e.g. increased payroll for yourself).
  3. Who doesn’t like more money?  Oh yeah, the Capital One Baby!

So let’s change things up and assume that Ricky owns his own delivery business.  He files his business income and expenses on a Schedule C so any profit from his business shows up on his personal return and is taxed at his marginal tax rate (25%).  For this tax year thus far, he has $50,000 in profit (income less expenses) from his business.

Instead of buying a house, he decides to spend $10,000 on some billboard advertising.  Now his profit is only $40,000 because the advertising expense is tax deductible.  But those ads generate $25,000 of new business.  Way to go Ricky!  So his profit then becomes $65,000.  Sure, he will have to pay $3,750 more in taxes ($65K – $50K = $15K x 25%) then he would have had to if he didn’t run the advertisements.  But the flip side is that he will be left with $11,250 in more cash.

Now, if Ricky has a smart tax accountant on his team (like us), they might tell him to open a SEP IRA where he could put almost all of that additional $15K above his original $50,000 profit towards his retirement savings.  Best thing about that is 1) it’s deductible on his tax return and 2) he’s funding the day he can park that delivery van for good!

Need some help with your tax planning?  Want to brainstorm on how you can best spend your money?  Give us a call or shoot us an email and we’d be happy to chat with you!

Until next time…

Tax Issues for Self-Employed Individuals

Wait, another tax?

Wait, another tax?

Many self-employed individuals are considered “sole proprietors” or “independent contractors” for legal and tax purposes.  This is true regardless of whether you are turning a hobby into a business, selling an indispensable widget or providing services to others.  As a self-employed person, you report your business revenue results on your personal income tax return.  The following are a few guidelines and issues you should keep in mind when pursuing your entrepreneurial spirit.

Schedule C – Form 1040
As a self-employed person, you are required to report your business profits or losses on Schedule C of Form 1040.  The income earned through your business is taxable to you as an individual.  This is true even if you do not withdraw any money from the business.  While you are required to report your gross revenues, you are also allowed to deduct business expenses incurred in generating that revenue.  If your business efforts result in a loss, the loss will generally be deductible against your total income from all sources, subject to special rules relating to whether your business is considered a hobby and whether you have anything “at risk.”  If it generates a profit, then you will have to pay taxes on it.

Home-Based Business
Many self-employed individuals work out of their home and are entitled to deduct a percentage of certain home costs that are applicable to the portion of the home that is used as your office.  This can include payments for utilities, telephone services, etc.  You may also be eligible to claim these deductions if you perform administrative tasks from your home or store inventory there.  If you work out of your home and have an additional office at another location, you also may be able to convert your commuting expenses between the two locations into deductible transportation expenses.  Since most self-employed individuals find themselves working more than the traditional 40-hour week, there are a significant number of advantageous deductions that can be claimed.  Unfortunately, we find that most self-employed individuals miss these deductions because they are unaware of them.

The Bad News  – Self-Employment Taxes
A negative aspect to being self-employed is the self-employment tax.  All salaried individuals are subject to automatic deductions from their paycheck including FICA, etc.  In that many self-employed individuals often do not run a formal payroll for themselves, the government must recapture these taxes through the self-employment tax.  Simply put, you are required to pay self-employment taxes at a rate of 15.3% on your net earnings, up to an annual income cap.  Beyond the annual cap, the rate is reduced to just the Medicare tax rate of 2.9%.

In an interesting twist that reveals the confusing nature of the tax code, you are allowed a partial deduction for the self-employment tax.  Simply put, you are allowed to deduct one-half of your self-employment taxes from your gross income.  For example, if you have to pay $10,000 in self-employment taxes, you are allowed a deduction on your 1040 return of $5,000.  Many self-employed individuals miss this deduction and pay more money to taxes than needed.

No Withholding Tax
Unlike a salaried employee sitting in a cubicle,  the taxes above are not withheld from your paycheck.  While this sounds great, you are required to make quarterly estimated tax payments.  If you fail to make the payments, you are subject to a penalty, but the penalty is not the biggest concern.  A potentially dangerous pitfall of being self-employed is failing to pay quarterly estimated taxes AND then getting caught at the end of the year without sufficient funds to pay your taxes.  The IRS is not going to be happy if you fail to pay your taxes and you will suffer the consequences in the form of penalties and interest.  Making sure you pay quarterly estimated taxes helps avoid this situation and it is highly recommended that you follow this course of action.  If you have encountered this situation for yourself, be sure to contact us immediately to help you remedy this particular circumstance.

Record Keeping
You must maintain complete records of all business income and expenses.  Simply put, document everything.  Create a filing system for each month and file every receipt, etc.  All business travel expenses must be documented, including auto mileage you incur when performing business tasks.  Office supply stores sell business mileage books that you can keep in your car and use whenever you travel.  There are even some apps for your phone that will allow you to push a button at the beginning and end of your trip and it will calculate the mileage for you.  If you have any doubt about documenting something, just do it!

As a self-employed individual, your focus and time is spent on making your business successful.  Your focus is not on the complexities of the tax code and how to limit the amount of taxes you owe.  If any of the information in this article is new to you, then it is highly likely you have paid far more in taxes than required.