Can I say that I just LOVE seeing so many of my friends promoting different products through direct selling? It's great to see so many find something they are passionate about and share it with their friends and family. I definitely understand the sentiment- just like those of you who love sharing your body wraps, pink drinks, EOs, skincare products, and nutritional supplements, I love being able to educate people on their tax obligations!
I wanted to focus my blog post this month on "Income Tax Tips for Direct Sellers" and I hope all my product-sharing, money-making friends find it helpful!
First, I want to start with a section of text pulled straight from the IRS' website, just for fun, really. (If you want to read all of it- here's the link!- http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Retail-Industry-ATG-Chapter-3-Examination-Techniques-for-Specific-Industries-Direct-Sellers)
The IRS says this about direct selling:
"Direct selling provides important benefits to individuals who desire an opportunity to earn an income and build a business of their own; to consumers who enjoy an alternative to shopping centers, department stores or the like; and to the consumer products market. It offers an alternative to traditional employment for those who desire a flexible income earning opportunity to supplement their household income, or whose responsibilities or circumstances do not allow for regular part-time or full-time employment.
The cost for an individual to start an independent direct selling business is typically very low (which is a major selling point for entering into this type of self-employment business). Usually, a modestly priced sales kit is all that is required for one to get started, and there is little or no required inventory or other cash commitments to begin. This stands in sharp contrast to franchise and other business investment opportunities that may require substantial expenditures and expose the investor to a significant risk of loss.
Direct selling companies market their products through person to person contact away from a fixed retail location through a network of independent sellers. Frequently these sales presentations are in the home, in the form of a sales "party," or through door to door solicitations, or sometimes, as part of a get-together – one person to one person. In any case, these approaches are all considered direct sales. In addition, direct selling provides a channel of distribution for companies with innovative or distinctive products not readily available in traditional retail stores, or who cannot afford to compete with the enormous advertising and promotion costs associated with gaining space on retail shelves."
I think the IRS sums up the principals behind Direct Selling so well, don't you? Let's turn the focus of this blog post toward the more important opinion the IRS has about Direct Selling now- how direct sellers should handle their tax obligations.
I did a little research about how many of the popular Direct Selling companies pay the individuals who sell their products, and it looks like most of you are classified as "Independent Contractors" and receive an IRS Form 1099 to report your income. For example:
- Rodan and Fields issues a Form 1099 MISC (non-employee compensation) to each Consultant who had compensation of $600 or more or made purchases in excess of $5000. https://www.rodanandfields.com/images/Archives/RF_Policies_Procedures.pdf (see 5m)
- Young Living also classifies it's distributors as independent contractors and notes in its Policies and Procedures handbook (http://familyfriendlyfarm.com/wp-content/uploads/2013/09/policies_procedures-YL.pdf Section 3.1) that "you are responsible for paying local, state, and federal taxes due from all compensation earned as a member. Young Living also provides you with a Form 1099 MISC (non-employee compensation) if you had earnings over $600 in the previous year or made purchases in excess of $5000.
- Plexus Worldwide classifies all Ambassadors as independent contractors also. https://store.plexusworldwide.com/JoinAgreement.asp (See Section 2B)
- It Works! Global's policies state that "each distributor is responsible for paying local, state, and federal taxes on any income generated as an Independent Distributor... Every year, It Works! will provide an IRS Form 1099 MISC (Non-Employee Compensation) earnings statement to each US resident who had earnings of over $600 in the previous calendar year or made purchases during the previous calendar year in excess of $5000. http://static.myitworks.com/pdf/ItWorksPolicies-Jan-2014.pdf (See 3.16)
Assuming you earned over $600 in 2014 through your Direct Selling endeavors and received a Form 1099-MISC, here's what you need to know about being an "Independent Contractor" for tax purposes.
- You must pay self-employment tax and income tax
- Self-Employment Tax: Social Security and Medicare taxes
- 15.3%; self-employed individuals pay both the employer and employee portion for themselves
- Income Tax: You must pay this through estimated tax payments throughout the year because they are not being withheld like an employee's taxes are
- Estimated tax is a percentage of all income not subject to withholding (self-employment, interest, dividends, alimony, rent, awards, etc.) and self-employment tax
- This percentage depends on your income bracket
- The amount you pay is usually based on your prior-year's income and tax bill
- Self-Employment Tax: Social Security and Medicare taxes
- You must file an annual income tax return
- You must file an income tax return if your net earnings from self-employment were $400 or more
- How to calculate and make Estimated Tax Payments
- Fill out a Form 1040 ES Estimated Tax for Individuals
- The worksheet uses your prior year's return to determine if you are required to pay estimated taxes
- If you have never had self-employment income before, you will need to calculate your estimated adjusted gross income, taxable income, taxes, deductions, and credits for the year
- The Form will produce vouchers for you to mail with your estimated tax payments Estimated taxes are due quarterly: April 15, June 15, September 15, January 15
- I advise you make Estimated Tax payments monthly or each time you get paid rather than quarterly and advise you use EFTPS (Electronic Federal Tax Payment System) to make these payments; it's MUCH easier that way!
- If you did not pay enough tax throughout the year, there is an underpayment penalty
- This is generally avoided if you owe less than $1,000 after subtracting withholdings and credits or you paid over 90% of the current year taxes/100% of last year's taxes (whichever is smaller)
- You can be penalized for not paying enough by each quarterly due date, even if you are entitled to a refund at the end of the year
- If your income is earned sporadically, you can avoid this penalty by annualizing your income and making unequal payments with a Form 2210
- Penalties can be waived if you had reasonable cause for not fully paying
- How to file your 1040 Income Tax Return:
- File a Schedule C or Schedule C-EZ with your personal income tax return to report income or losses for the profession you practiced as a sole proprietor/the business you operated
- The Schedule C-EZ is for small businesses and statutory employees with expenses of $5,000 or less
- To report Social Security and Medicare taxes, file a Schedule SE
- This uses the income from your Schedule C to calculate the amount of Self-Employment taxes you should have paid
- A few notable deductions for "Independent Contractors"
- Be sure to carry a log book with you on your travels (or check out apps available for your smart phone) to keep track of your mileage
- Home Office Deduction - if you use part of your home for business, you may be able to deduct expenses for the business use of your home (rent or own)
- "Safe Harbor" method - claim a standard deduction of $5 per square foot of portion of home used regularly and exclusively for business, up to 300 square feet
- Traditional method – calculate actual expenses of home office as a percentage of square footage of your home office consumes
- You can choose your method from year to year; whatever you choose must be applied consistently for all businesses you operate from home
- Under the new method, you can claim allowable mortgage interest, real estate taxes, and insurance losses, but you cannot depreciate the portion of your home used for business; with the traditional method, deductions have to be allocated between personal and business use
- A good way to lower your AGI while also saving for your future is to contribute to an IRA, SEP IRA, or other qualified retirement plan; you can claim a deduction even if you do not itemize
- Other deductible items include uniforms, cell phones, depreciation, family health insurance premiums, legal and accounting fees, professional dues and subscriptions, business insurance and licenses, equipment, etc.
I hope this was helpful! Call or email me if you have any questions, and for more tax information and updates follow us on Twitter, @BrysonLaw, Like us on Facebook, or check out our website!