The IRS and You

 

I received an email from a good reader and participant here at Webcomic Alliance, Robin Dempsey of http://leylinescomic.com.  She asked some great questions about starting up a business.  Eventually, all us artists will sell stuff and have some sort of income from our work.  How do we handle it?  What are the legal and tax aspects of starting a business?  What can you and can you not claim on tax forms?  So, relax and let’s dive in to find out the answers!

I am not a lawyer or an accountant, but I will give what is *my* knowledge on these questions.  I have been self-employed for over 25 years and have run corporations and sole proprietor businesses.  These are somewhat generic answers, as some will be based on your state laws as well.  Let’s start!

– If I DO declare a business, but don’t get in the black by the end of five years, what are the real consequences?  I’ve heard everything from “nothing” to “the government takes your business.”

The government cannot “take” your business, but the can put a lien on your business and sometimes personal assets.  Now this only happens if you owe thousands and thousands of dollars in taxes.  Even then, they don’t want your business, they want the money.  You will need to get an accountant and they will advise you on your local/federal tax questions… but, if you run a business in the Red years on end, the government does not take kindly to it as they will go “Why are you running it if you’re making no money?” And this could trigger tax audits.  Now, if you’ve run the business legitimately, then you have no worries.  There were many years in a row I ran my business at a “loss” but technically made money.  It is possible with tax loopholes.  First rule of any business: Get an accountant.  They’re worth the money.

– If I DON’T declare a business and rack up large expenses, is it a waste because there is no tax return on those losses?  If I declare later, does something retroactively get applied?

Again, an accountant can answer this question for your individual situation.  As a sole proprietor, your business income will be declared on your personal tax returns, there are no special forms involved (there are, but mostly in special cases).  The IRS doesn’t care where it came from, so there is no need to “declare” a business.  In general, the day you start earning money, you’re in business.  You do not have to “declare” you started it; you have income to prove you did.  Simple.  As long as the income and expenses are declared in the year in which you’re filing, then it is pretty straight forward.

Now, if you wait two years and try to go back and amend your tax returns to take losses, it may send up a red flag and the worse case scenario is an IRS audit.  Do not fear the IRS, they work for you… you pay them.  Again, a good accountant will cover you with the IRS… that’s their job.

– If I DON’T declare a business but start earning profits, am I going to find the IRS at my door?

No.  Only on declared income do they care.  Look at all the craft shows going on and people being paid in cash. Are they declaring that money?  Most of them: No.  Only the ones that want to declare the EXPENSES associated with that income.  But when people get careless and start taking in thousands of dollars in cash and buying expensive stuff, someone will notice and will want to know how you acquired that new sports car on a Wal-Mart salary.

In our case, book printings, conventions, travel, etc. we’ll want to take off our income as business expenses.  You can only do that if you claim income.  Again, an accountant will advise you properly.  The best thing: Declare your income.  Another benefit to running your business from your home is you can deduct a percentage of your home expenses (utilities, mortgage, etc.) off of your taxes.  So declaring income allows you these benefits.

– If I DON’T declare a business and manage to run into some sort of legal problem, did I just put everything at risk by basically operating as an undeclared sole-proprietorship with unlimited liability?

Again “declaring” a business is a minor issue.  Even if you were to register as a business with your state, you’re offered no protection as a sole proprietor.  As a sole proprietor, you’re on the hook no matter how the business has been registered.  If someone tries to sue you because they tripped on your table cloth at a convention, you’re on the hook and you have no protection for your personal assets.  The only way to obtain that protection is by incorporating (generally speaking these costs are about $1000, depending on the state).  By being a corporation, you HAVE to have an accountant, there are way too many tax laws to know and you’ll need advice on how to best handle your income tax forms (you’ll have personal taxes and corporate taxes).  Now, I incorporated once I got an office and employees, that way no one could sue me personally.  They can try, but I’m protected by corporate law then.  They can sue the company, but they can’t sue me, so my house and car are protected.  The odds are small you’ll be sued, but it does happen.  You’ll have to make that decision based on your own personal preferences.  If you have the $1000, then incorporate, it does provide some peace of mind.  Currently I am not incorporated (various technical reasons) but I have owned two corporations and in one case it saved my butt (but I was doing close to a million a year in billings by then).

– If I DON’T declare a business, but create a separate account for all business-related transactions and treat my property as a business, will that make it easier or harder to declare later?

The moment you open an account (checking I’m assuming) you’re in business. By having a separate account for your business income and expenses, it will make it immensely easier to handle your taxes.

You seem to use the term “declare a business” and you really don’t do that.  You start making money, you’re in business.  Kinda simple.  But, you will need to REGISTER your business for SALES TAX purposes.  You only need to register with your state if you are going to collect sales tax.  There is a term called “an occasional sale” that applies to us artists just starting out.  What it means is I can go to a convention, sell 50 books at $10 each and not pay any state sales tax as the income (the $500) is NOT my primary income… it was an “occasional sale”.  Now you have to be really careful with this, but for the most part in the beginning (emphasis on “in the beginning”) I would not worry about collecting sales tax.  Once you start making good money (again, over $1000 a month) then you’ll want to collect sales tax.  My wife runs a pottery business and for the first 10 years did not pay sales tax, as the income was minor to our total income and qualified as an “occasional sale”.  But the past 13 years, she has paid sales tax as she was doing $2000-$3000 per show.  And to write off those expenses, she had to declare the income and pay sales tax (you file quarterly with your state typically).

Over all, the IRS and your State have limited powers on you, but they can make life rough for you.  If you play it straight, you’ll more than likely avoid any interaction with either of them.  Again, they’re looking for big violators.  They don’t have time for people making $500 on the weekend at craft shows or conventions.  It’s not worth their time.  The real answer here is getting an accountant if you’re serious about doing your own business.  They’ll answer all of these questions (for a price).  You’ll only need a lawyer if you decide to incorporate.  Accountants are not legal representatives, but can represent you in tax issues with the IRS and State.

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11 Comments

  1. Great roundup.

    Given my earnings, my accountant still shows my earning/expenses as line items and declares it a hobby. When/if revenue increases then I will probably file a separate business return.

    • I use the usual on-line Tax return software and it simply asks me if I have a business and does all those forms for me. But, as you’re doing, when the income is not significant, the accountant knows how to stick it on your return. Some folks are like “Why report a small income at all?” and that’s true, it would be hard for the IRS to know exactly what you’re doing, but as you grow and YOU do starting claiming business income, if you’ve been doing it for many years, even at a small rate of income, it shows growth. That’s important too sometimes.

      Depends if this is a permanent hobby or one that will become a more significant income for you. Since I’m already self-employed,it was no big deal for me to claim my comic sales income.

  2. The IRS has a great website for answering questions just like this. (surprisingly)

    I’m not sure if I can post a URL here but it’s exactly where you’d expect at IRS dot GOV and you can find federal return info in PLAIN LANGUAGE there.

    This doesn’t take into account your STATE requirements for opening a business though, and you really need a good book (with your STATE requirements outlined) to answer these questions.

    It’s not hard….it can’t be….too few people would even TRY to comply if it was. Just search the gov sites online, find a book, and dont’ panic! 🙂

    • I stated in the second paragraph these were generic answers as some will be based on state laws. The BEST thing is to hire an accountant. In the beginning, it’s easy to go cheap as you don’t have a lot of cash, and that’s when you’ll make the big mistakes. Get an accountant… they know the tax laws. Let them guide you. It’s their job.

  3. Byron, I cannot express how helpful these responses were, and I hope other WA readers gain as much peace of mind as I did from them. I’ve scheduled an appointment with an accountant that a friend recommended, one with small-business experience.

    I also purchased a book that I am finding VERY helpful, called “The Small Business Start-Up Kit: A Step-by-Step Legal Guide” by Peri H. Pakroo J.D., published through NOLO – http://www.amazon.com/gp/product/1413310990/ref=oh_o00_s01_i00_details . It lays out in simple, plain language answers to a lot of questions I had, such as:

    – When does “hobby” become “business”?
    – What business type is right for me?
    – Should I register a trademark for a business name? What about copyrights?

    And that’s just the first two chapters! It’s not a book that makes me 100% autonomous, but I now feel prepared to ask targeted questions when I meet with my accountant. Good-bye panic, hello preparedness!

  4. It’s a shame that this is all for americans wanting to start a business. It would be great to have a Canadian version for the small subsection of us that are north of your border that would like to start a business with our comic and have the same questions. I’m sure there are a lot of parallels, but I know there’s going to be one or tow things that are just slightly off but may catch somebody new starting out. Great article regardless of it’s geography constraint.

    • Well, my focus is unintentionally on the USA due to my geography. But, I will ask Antoine Gagnon and/or Kurt Sasso to give me some Canadian pointers and do an article here shortly for our friends north of the border. Thanks for reading and I’ll get to that as soon as I can.

      • That would be super awesome. It’s unfortunate that the majority of webcomic advice is unintentionally american. I get that though. It’s a wider audience. I’d love to hear what your Canadian authors also have to say on shipping books, t-shirts and such from Canada. I’ve been trying to find a reasonable way to ship cheaply and effectively. anyways again great article. and thanks!

  5. Just a note… I have a tax accountant in our family that does our taxes. When it comes to what I earn for the kids book and Z&F, he says don’t worry about filing taxes until I am considering quitting my 9-5 job. and that’s waaaaaaaaay off in the future it seems. Declaring myself a business falls in that area as well. (goes hand in hand)

    Helpful info Byron ;0)

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