Barbara asks:

My 16-year-old son earned $1,250.00 in modeling income this year. He was issued a 1099-MISC and his income was reported in Box 7. Does he have to report this income and pay a self employment tax?

Initially when I first started reading your e-mail, I thought it was going to be a kiddie tax issue. Thank Goodness it’s not. To answer your question, in one word, yes.

For dependents — and at 16, I imagine he’s still someone’s dependent — a return is usually not required unless any of the below apply:

  • Unearned income (think dividends, interest, etc.) was over $950.
  • Earned income was over $5,700
  • Gross Income exceeded the larger of $950 or earned income (not to more than $5,400) plus $300

And since the income your son received is considered earned income, and it wasn’t more than $5,700, on that front he’s fine.

Now, even if the above criteria aren’t met, as long as your son earned more than $400 of self-employed income, then he’s required to file a return and report self-employment tax.

Self-employment taxes are simply the employer and the employee portion of social security and medicare taxes. Both of which would have been deducted from wages if you receive a paycheck. Your employee would then match these taxes (except for in 2010).

Quick note: When I originally published this post, I neglected to mention the implications of self-employment tax.

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine—though you can be—it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult your tax professional before relying solely on any information provided on this site.

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Taxpayer says:

Hello and thank you for your helpful website! I have been unable to find an answer to this question and I hope you can help.

I live in California and work part-time for a small business that is a corporation. I will be moving to Texas and my current employer and I have agreed that I would begin working for myself as an accountant. I will get a business license and be working for the same company as a bookkeeper. I will set my own schedule and help with payroll taxes and basic accounting for the company.

My question is this: Will there be any difficulty in my being a W-2 employee and 1099 Independent Contractor in the same year? For my employer or myself?
Also what forms should I fill out to make sure everything is legal and kosher?

I have researched this subject on irs.gov and I will qualify as a Independent Contractor as far as I can tell. Being the one who dictates how, when and why I do things for the company and no longer an hourly employee answering the phones and setting appointments. Also I may expand in the future to other small business (in Texas most likely) that will allow me the same freedom to work online from home as an accountant or bookkeeper.

First, congratulations are in order. Making the move from employee to self-employed is quite an accomplishment.

It seems like you’ve obviously done your homework on the independent contractor classification. Nowadays, the IRS will tend to look at the level of control you have regarding the work being performed. There are 20 factors that the IRS will consider when determining who qualifies as an independent contractor—from things such as whether you set your own hours, perform the work on your clients’ premises, work for more than one person, etc. The full list with a bit of guidance can be found here.

It sounds like you should be fine, and there is absolutely nothing wrong with you going from an employee to an independent contractor in the same year. I know of a few instances where employees have gone from being employees, to freelancing on the side, to being full-time self employed—all in the same year. In a couple of those situations, their employer ends up being one of their clients.

As for the what you should do, definitely apply for an EIN, if you haven’t already done so—it’s fast, and you’ll have the number in minutes. It also wouldn’t hurt to have some kind of contract or written agreement, such as an engagement letter. Also, give them a signed copy of a W9.

Good luck and enjoy being an entrepreneur!

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine—though you can be—it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult your tax professional before relying solely on any information provided on this site.

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The IRS is clearly trying to embrace technology. First there was Twitter, YouTube, and now an application for your smartphone.

The app is called IRS2go, and is available on both the Android marketplace and the iPhone App Store.

The app currently allows you to check the status of your refund, subscribe to IRS news, follow them on Twitter, and it also provides their contact information. I suspect most people will be using it to check the status of their refund.

I’ve tried it, and I must say it’s really simple and easy to use. Not necessarily what I was expecting when I initially downloaded the app.

To check the status of your refund, you simply enter your SSN, filing status (single, head of household, etc.), and exact dollar amount of your refund.

I even used it to check the status of my 2009 refund (though the app prompts you to enter your information for your 2010 return—I suspect that it just pulls the last return you have on file).

The contact option is pretty useful; it not only gives you the contact number for each unit, but also gives you the hours of operation with a link that automatically dials the number (at least in the iphone version).

It’s a win-win situation: you can quickly check the status of your refund—even while waiting in the dentist office— and they get less calls inquiring about refund status.

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I previously mentioned that the IRS wouldn’t be ready to accept certain e-filed or paper returns until sometime in February. They’ve now announced a definitive date: February 14.

The returns that are impacted are those that claim deductions on Schedule A (mortgage interest, property taxes, medical expenses, etc.), the higher education tuition and fees deduction on Form 8917, and the educator expense deduction.

Also as previously mentioned, just because the returns won’t be accepted by the IRS until February 14 doesn’t mean that you can’t prepare them before that; you or your tax preparer will just have to hang on to them until then.

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This question was asked in the comments section of one of my Ask the Tax Pro posts, and it’s a really good question; one that I get asked often.

Taxpayer asks:

I was sued in 2010 for a divorce that never went through. I spent $3,000 in atty fees. I am self-employed as a Physical Therapist independent contractor. Is there anywhere I can legitimately deduct the $3,000 in fees paid to protect my business accounts and assets?

Legal fees can be split into two categories: personal and business. Legal fees incurred in connection with a business are always deductible—so long as the expenses are ordinary and necessary. However, with the exception of fees paid in connection with collecting alimony or for tax advice, those fees that are personal in nature are generally not deductible.

In the case of a divorce, legal fees are almost always considered personal expenses, and, as such, are not deductible. This is true even if it affects your business.

At this point you’re probably saying to yourself, “but I paid the fees to defend my business assets; shouldn’t I be able to deduct this as a business expense?” I hear you. But unfortunately the Tax Court doesn’t agree. They previously ruled that whether or not legal fees are deductible depend on how the claim originated, not the consequences should you fail to defeat the calm.

From what I can tell, the fees you incurred were solely because of the divorce, which is personal in nature, and, therefore, isn’t deductible as a business expense.

Also, keep in mind that if you were allowed to deduct the fees as a personal expense, you only get to deduct the amount that exceeds 2% of your adjusted gross income (AGI). This means that unless your AGI exceeded $150,000, you wouldn’t be able to deduct any portion of the $3,000 expense (150,000 x 2%=$3,000).

I’m sure this wasn’t the answer you were hoping for, but such is the case sometimes when it involves the tax code. Good luck with you business!

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine—though you can be—it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult a tax professional before relying solely on any information provided on this site.

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Ask the Tax Pro: I Was Audited, Can I Still File?

Tabari asks:

I was audited last year, but with all the moving, I never received my audit paperwork, can I still file this year or do I need to take care of the audit first

While getting audited isn’t fun, having to also pay penalty and interest for late filing a return would be even worse. So go ahead and file your 2010 return.

While you’re at it, reach out to the IRS examiner that was handling your audit to find out the status. An audit is just not something you want hanging over your head.

If the audit is still pending, depending on your circumstances, you may even want to hire a tax professional to assist with the audit.

Good luck!

Disclaimer: like any decent tax professional will tell you, since you’re not currently a client of mine — though you can be — it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult a tax professional before relying on any information provided on this site.

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Tax Season 2011 — Are We There Yet?

The 2011 tax season officially opened for business yesterday, with a few kinks no less.

First, the good news: you now have 3 more days to prepare your return. Returns will now be due on April 18 instead of the usual due date of April 15.

The due date extension is apparently so there aren’t any confusions with Emancipation Day, which is observed on Friday, April 15. Those taxpayers who itemize deductions on Schedule A, claim the tuition and fees deduction, or claim the educator expense deduction will need to wait until mid-February before they can e-file their return. The IRS estimates that this should affect less than 7% of taxpayers.

Keep in mind that the return can still be prepared now, the IRS just won’t be prepared to except them for another month. Most paid preparers and some commercial software providers have said they will prepare the return now and wait until they receive notification from the IRS to e-file.

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Ken, who runs a for-profit consignment gallery asks:

We have always filled out 1099-Misc forms for all of our artists who earn more than $600. I have an artist who is insisting that she doesn’t need to provide her tax ID # to us because her artwork is a good and not a service and therefore does not fall under the 1099 form. Can you help me resolve this?

Ken, the quick answer is she’s right, but not for long.

You’re normally required to issue a Form 1099-Misc to all non-employees that you pay more than $600 for services — corporations are generally exempt. Since her artwork is a tangible product and not a service, it doesn’t fit the requirement for non-emloyee compensation.

However, starting in 2012, a 1099-Misc will have to be issued for practically everything. The exemption for corporations and payments for products will no longer apply. So any business that buys products from, say their local office supply store, will have to issue a 1099-Misc to them so long as they make payments of over $600 in any given year. I know, it’s absolutely ludicrous, which is why so may people and organizations are completely against it. It places an unnecessary burden on small business especially.

You don’t need to issue her a 1099-MISC for 2011, but starting in 2012, she — and all the other artists you work with — will have to provide you with her Taxpayer ID so you can issue her a 1099-Misc if you pay her more than $600. And you will also be required to issue a 1099-Misc to any business that your gallery pays more than $600, corporation or not.

Hope that helps.

Disclaimer: like any decent tax professional will tell you, unless you’re an actual client of mine — and currently you’re not — it’s almost impossible to provide complete and accurate tax advice over the internet without being aware of the taxpayer’s entire situation; therefore, I suggest you consult a tax professional before relying on any information provided on this site.

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What the Tax Deal Would Mean for You

For a while there has been nothing but talk about the Bush-era tax cuts.  Millionaires wanted them elliminated.  Republicans wanted them to remain in place, permanently even.  Then this week you heard that Obama announced a deal was made with Republican leaders regarding said tax cuts.  But what exactly does it all mean?  And how could this new deal effect you?

Bear with me as I try to make sense of it all.

But first, a quick explanation of what these tax cuts are: In 2001, and again in 2003, there were a series of tax breaks that were enacted to help stimulate the economy.  If nothing is done, these tax breaks would basically be nonexistent after 2010. Hence the debacle we’re now in.

Now, let’s take a closer look at the provisions in this deal.

1. Tax Rates  Tax rates were initially lowered during President Bush’s term.  A new 10% tax bracket was created.  And most rates dropped by 3%.  Should this deal be enacted, the lower rates that we had in 2010 would be the same for 2011 and 2012.

2. Estate Tax  This is probably what has upset Democrats the most.  The deal makes the top rate 35% with an exemption of 5 million.  Yeah, 5 million dollars.  At this point, for most Americans, there would be no estate tax for 2010 and 2011.  I mean, seriously, that’s a 10 million dollar exemption for a married couple.

3. Capital Gain.  These rates would remain at its all-time-low of 15% for long-term gains for two years.

4. Dividends  Same as with the capital gain rates, the top rate of 15% would remain the same for two years.

5. Unemployment Benefits.  Apparently this is the reason Obama agreed to this deal in the first place.  Federal unemployment benefits would be extended through 2011.  I’m sure some of those that are out of work are breathing a sigh of relief right now.

6. Payroll tax The social security tax rate would drop from 6.2% to 4.2% on the first $106,800 earned.  Note that this rate decrease is for the employees’ portion of social security taxes only.  And unlike the other provisions in this deal, this one will only last for 1 year.

7. Child Tax Credit.  This was raised to $1,000 per child during the Bush-era.  Guess what would be extending for another 2 years?  You guessed it. The $3,000 earned income that was needed to make the credit refundable still stands as well.

8. American Opportunity Tax Credit Specifically the modified version of the Hope credit with an increased available deduction of $2,500 – instead of $1,800 – would also remain the same.

9. Earned Income Tax Credit  What is probably the most abused and controversial of all tax credits also gets extended.  The base amounts were changed to allow more low and middle class family to be eligible for the credit.

10. State and Local Sales Tax Deduction  This went away in 2009, and from what I’ve read, there is a posibility that it could be brought back – maybe even without the need to itemize.

11.  Deductibility of Real Estate Tax Without Itemizing.  You’ve always been able to deduct real estate taxes, but just like last year, you would be able to deudct them even if you didn’t itemize your return. It would simply increase your standard deduction.

12. Transfer of IRA to Charities  Taxpayers that are over age 70 1/2 can transfer their IRA balance directly over to a charity.

13.  And before I forget, ATM  We got a patch.  Again.  How many times are we going to dance this dance?  Seriously?  Just get rid of the damn thing already.

And that, my friend, is what this deal would mean for you.  Some of it will affect you directly, then again some won’t.  But make no mistake about this, it will affect us all.  How much do you think all of this is going to cost? If you answered anywhere close to $900 billion, then you’d be right.

President Obama gets unemployment benefits and lower social security tax, and apparently the Republicans got everything else.  No wonder the Democrats are upset.  So much so that Nancy Pelosi and other House Democrats passed  a resolution stating that the package should not come to the floor of the House of Representatives.  At least not in its current form.  They want changes.  Then again, don’t we all.

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2011 Mileage Rates Announced

The IRS recently announced the 2011 mileage rates for business, medical, and charitable purposes.  The rate for business miles increased from 50 to 51 cents, medical and moving, increased from 16.5 to 19 cents, and charitable miles remain unchanged at 14 cents per mile.

The mileage rates are based on an annual study performed by Runzheimer International.  The study determines the cost of operating an automobile, and based on that amount we get the standard rates.

If you’re thinking that this wasn’t much of an increase, you’re right.  However, considering that we went from 55 cents in 2009 to 50 cents per business mile in 2010, I’m okay with the minor increase.

One quick tip: using the standard mileage rate isn’t always better. You get a choice (imagine that!) of using the standard rate or using your actual automobile expenses. Sometimes, the latter can amount to more of a deduction that using the standard rate. It, however, requires that you actually keep track of your expenses (repairs, insurance, gas, oil, registration fees, lease payments, etc.). Taking the standard deduction is easier, but sometimes a little hard work will pay off.  If you’re driving for business purposes, you should be keeping track of those expenses anyway.

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