Ask Linda: I moved to consulting status - now what?

linda-round SMALL 2.24*.png

Dear Linda, I recently transitioned from being a salaried employee to a self-employed consultant. I like the flexibility but realize that I have more responsibility with regards to my finances. For example, I was previously enrolled in my employer's 401k plan and now I am not sure how to save for retirement. I am also confused about taxes - my employer withheld money from each paycheck but no taxes are being withheld when clients pay me. And people keep saying I can "write things off", but I am not sure what that means.

Consultant Christopher

Dear Christopher,

This transition can be confusing, but as long as you stay organized you will be fine. Here are some recommendations to help get you started.

Track all income & expenses related to your consulting work.

Open a separate bank account for business activity. Save all invoices and receipts relating to the business transactions. While not necessary, we also recommend using a bookkeeping software, such as Quickbooks Online, to generate invoices, attach receipts to transactions, and run reports that will help you at tax time.

Pay your taxes throughout the year.

You may need to calculate and pay estimated tax payments. Alternatively, you can increase your spouse's withholding if you are married and filing jointly. If you do not withhold or pay enough in estimated taxes you may incur a penalty. Work with a tax preparer if you have any concerns about the calculation or process.

Take advantage of "write-offs" and document your work mileage.

Deductions, or "write off's", are eligible expenses that reduce your taxable income. Examples include advertising costs, professional fees, and insurance premiums. You can also write-off expenses related to your work area at home as long as it is used solely for work. If you drive for work, you can deduct car expenses but a mileage log is required to justify the deduction. It is hard to re-create this at tax time so start keeping track now if it is something you plan to deduct. Leave a notebook in the car that lists the date, mileage and business purpose of each trip including the start and end location. You also need the odometer reading the first and last days of the year that the car is used for business (the tax return will ask for personal vs. work miles). There are phone apps that track mileage including one that links up to Quickbooks, so find what works best for you.

Continue saving for retirement.

Check with your financial planner to determine the best type of retirement account to use. Examples include the SEP IRA, Traditional IRA, Single 401k and Roth IRA. They all have unique characteristics and contribution limits so it will depend on your tax bracket, expected income, and other details relating to your personal situation.

Re-evaluate your personal insurance coverage.

Don't forget to seek out any coverage you may have lost when you transitioned to self-employment. Examples include medical, life and disability insurance.

Good luck!

This information is not a substitute for tax advice. We recommend speaking with your tax advisor if you have any questions relating to your particular situation. PWR offers Tax Preparation and Advisory Services. Learn more.

"Ask Linda" is a monthly personal finance column where the founder of Planning Within Reach, LLC, Linda Rogers, picks one question from her readers and publishes a detailed answer with the hope that it benefits others. If you would like to ask Linda a question, email her or contact her on Twitter.

The Tax Implications of Donation-Based Crowdfunding

andrew-neel-218073-unsplash.jpg

Are you considering setting up a crowdfunding campaign for yourself, or someone you know, to help pay for medical bills, tuition, or raise money for a cause? While there are different types of crowdfunding, we address donation-based crowdfunding in this post since it is the kind we see most often. Money received from donation-based crowdfunding should be considered gifts, and therefore non-taxable. However, payment processors used by crowdfunding sites, such as Paypal, may issue a Form 1099-K to the recipient regardless of whether the crowdfunding proceeds are taxable or not. The 1099-K notifies the IRS that the taxpayer received income from a crowdfunding site, and if the taxpayer did not claim the income on their tax return (thinking it was a gift), the IRS may issue a deficiency letter.

The burden of proof lies with the taxpayer. Even if the funds should be non-taxable, typically these letters go out after time has passed and the taxpayer doesn't have sufficient documentation to verify the nature of the crowdfunding proceeds. To prevent confusion, we offer the following guidelines in approaching this type of transaction. The goal is to be as proactive and transparent as possible in the event you are challenged on the tax implications of your crowdfunding proceeds.

1) When you create a crowdfunding website, include the following details:

Campaign Purpose - Define what the campaign proceeds will be used for. Beneficiary - Identify who will be receiving the funds raised during the campaign. Creator - If the campaign is created by someone other than the Beneficiary, clearly identify that person as the Creator and note that he/she is acting on behalf of the Beneficiary listed. Donations - State that donations to the Campaign Purpose are solicited and donors will receive nothing in return for their donation.

2) Save an electronic copy of the crowdfunding site with all the details outlined in #1. Your campaign website may be removed by the time the IRS issues a deficiency notice. Maintaining a copy allows you show that the transaction was clearly labeled.

3) Keep documentation of the money trail. For example, if you create a website for a friend, you will receive the funds from the crowdfunding site, and the potential 1099-K, even though you created the site for someone else and didn't keep the money. To protect yourself, you need to be able to verify that you transferred this exact amount to your friend.

4) Maintain records to prove that the donations received were spent as promised according to the Campaign Purpose. Following the above example, the ultimate recipient of the funds (my friend) must have documentation to show that he/she spent the proceeds according to the Campaign Purpose.

Payment processors are only required to send out 1099-K's if the campaign had more than 200 contributors and raised more than $20,000.Regardless of what success you expect from your campaign, it is good policy to follow these steps. All income is taxable unless you can prove it qualifies as an exception. Even if you don't receive a 1099-K, you may still get questioned about the transaction if you get audited.

This information is not a substitute for tax advice. We recommend speaking with your tax advisor if you have any questions relating to your particular situation. The rules are complicated and these steps are not a guarantee that your argument will work with the IRS.

Source: March 2018 issue of Journal of Accountancy.

Ask Linda: Gifting Stock to my Child

Ask Linda: Gifting Stock to my Child

I am a widow and want to gift some of the individual, concentrated stock in my brokerage account to my only child, my adult son. I am tired of managing the stock and feeling like I need to stay on top of the earnings reports, news, etc. I would rather gift it to him and have the rest of my portfolio in low-cost, diversified positions. The stock has a very low basis and will incur a large amount of long-term capital gains upon selling. What are your thoughts?

Read More

Does your tax return contain an IRS red flag?

daria-nepriakhina-6030-unsplash.jpg

If your 2017 return contains one or more of these red flags, you have a higher likelihood of receiving some sort of correspondence from the IRS. Don't panic. You just need to double check your numbers and confirm you are organized with your documentation. You should be doing this regardless, but you may find it useful to know where to be extra careful. Red flag #1: Page 1 of the 1040, Other Income (line 21), is filled out

This line is for very uncommon income items, such as jury duty pay or taxable distributions from a qualified tuition program. Instead, many taxpayers place self-employment income here. Even if you don't have any expenses associated with the self-employment income, most should be using Schedule C instead. Schedule C will generate self-employment tax, unlike line 21.

Red flag #2: You are claiming a deduction for a home office

The code is very specific and detailed about what a taxpayer can deduct with regards to a home office. For example, the home office must be a space in your home that is used exclusively and regularly as your principal place of business. There are additional requirements if you are an employee. This doesn't mean you shouldn't claim a home office if you are eligible, but make sure you are doing it within the IRS code limitations.

Red flag #3: Not reporting all of your income, or input errors

Copies of the tax forms you receive, such as W2's and 1099's, are also being sent to the IRS. They have an automated system to confirm that what you report on your return matches those tax forms. If you make an error or fail to report income, they will notify you. When I left my job at a financial software company in New York City, the firm asked me to do consulting for them to help transition the employee taking over my position. I did it for a short time at the beginning of the year, and by the time next tax season rolled around, that small amount of income wasn't on the top of my mind. The company sent my 1099 to an old address on file and I never received it. Thankfully, something jogged my memory shortly after filing and I immediately amended my return to include the income. It is easy to make mistakes, so keep good records and follow-up on any tax forms expected, but not received.

Red flag #4: You have a lot of even numbers on your return

We use even numbers in our financial plans because we are estimating and trying to make things simpler. This is not the way things work in real life or on your tax return. The IRS expects to see random numbers, so if they see a lot of deductions that are rounded to the nearest 100, for example, they may assume you are estimating and contact you for substantiation.

Red flag #5: There are unusually large amounts of business or charitable deductions on your return

The IRS keeps track of the average business expense associated with a given industry. Similarly, they track the average charitable contribution as a percentage of income. If you are taking these deductions at a rate that is higher than average, they may contact you for details. Along the same lines, if you only have one vehicle and claim it is 100% for business, that seems unrealistic. If it is the case, make sure you have detailed records to back up your claim.

What to do if the IRS contacts you

As a reminder, the IRS will initially contact you via USPS mail. They will not call, email or contact you via social media demanding immediate payment or ask for identifying information, such as your social security number or bank account. Here is more info on protecting yourself from tax scams.

When you receive a letter from the IRS, have comfort in the fact that many letters don't carry bad news, don't require a response or are very easy to answer. If you are working with a tax preparer, contact them as soon as possible and they will help you through the process. If not, read the letter in detail to make sure you understand what it is saying and that you agree with it, then move forward with a solution. Remember, the IRS makes mistakes too! If that is the case, respond with a detailed letter and any backup documentation necessary to correct the error. The most important thing to remember is to not panic or ignore the letter. By delaying your response, if required, you may be limiting your options to remedy the situation. Once you are done, scan and file the notice with the rest of your documentation for that respective tax year.

PWR prepares taxes. If you are looking for help, review our services page or schedule a free call to learn more.

Tax Season 2016 FAQ's

Every year, I compile a list of the FAQ's I get during tax season to share in the hopes it answers somebody else's question.  This is not a substitute for tax advice.  Please check with your tax professional for questions specific to your situation.

I have a taxable account, but I did not receive a 1099-INT form for it.  I looked online and I earned $7 of interest in 2015.  Do I need to claim this interest income on my tax return?

Yes - claim the interest income.  Banks are only required to issue 1099-INT forms on accounts with income greater than $10 for the year.  Regardless, all income is taxable (even if it is below the reporting requirements).

What is the 1095 form I received this year?

This form proves that you had health insurance for the entire year in 2015.  The majority will only need to check a box on their tax return attesting to coverage.  Those who purchased insurance on the Marketplace will get a 1095-A form and will need to fill out more information to see if their advance premium credit was accurate.  The 1095-B and 1095-C are purely informational, but still need to be kept with your other tax documents in case you get audited.

I am considering installing solar panels this year.  What tax benefit do I receive from this, if any?

You can claim 30% of the cost to install qualified solar systems as a federal tax credit. 

Is unemployment income taxable?

Yes.

I started a business.  Can I deduct expenses related to my home office?

Yes, but only if the area for your home office is exclusively and regularly used for your business.  It cannot be used for personal as well as business reasons.  See the other requirements and details here.

Can I deduct the cost of my child's summer camp? 

You may be eligible for the dependent care tax credit if the child is your dependent, under age 13, and sending him or her to camp allows you to work.  Check out IRS Publication 503 for more information.

How do I value my non-cash charitable contributions?

Use TurboTax's Its Deductible tool.