There’s been a large increase lately in the popularity of multilevel marketing companies and people, especially women, becoming a part of these businesses as a side income or even as a full time career. The rise of these companies such as Stella & Dot, Avon, Mary Kay, Young Living, Herbalife, Rodan + Fields creates a unique tax situation that many of these direct sellers may not be familiar with. Read on for some common tax questions associated with direct selling and what you need to know:
Q:How does the IRS view direct selling?
A: Generally, multilevel marketers are considered direct sellers. The IRS defines a direct seller as “a person who sells consumer products to others on a person-to-person basis, such as door-to-door, at sales parties, or by appointment in someone’s home.” A direct seller, as the sole proprietor of his or her business, is considered to be a self-employed, independent contractor, and the only owner of this unincorporated business. (Husband-and-wife teams are considered to be a single owner; any other business unions, for tax purposes, are deemed a partnership or corporation.)
Q:What forms do I file?
A: Three kinds of federal business taxes apply to direct sellers: income tax, self-employment tax (your social security and Medicare tax), and employment tax. Most of your tax information should be recorded on Form 1040 and its subsequent parts, such as: Schedule A for itemized deductions, Schedule C to record profit or loss, Schedule C-EZ for net profit from business, and Schedule SE for self-employment tax.
Self-employment tax is where many people really get hit. Because you’re not a W-2 employee having Social Security and FICA taxes withheld from your pay, the IRS requires you to pay the full portion (the employer and employee portion).
Employment taxes apply to direct sellers who hire employees (such as a regular secretary). The people in your downline are not considered your employees–consider them independent contractors. If you pay someone more than $600 in a given year, you are required to issue them a 1099-MISC at the end of the year– the same form you will receive to show income for your income/commissions from your product company.
Q:Do I need an Employer Identification Number?
A: Few direct sellers need an EIN. Most use their social security number as their identification number. If, however, you have a Keogh plan, hire employees, or operate your business as a corporation or partnership, an EIN is required. You may apply for an EIN by using Form SS-4. An EIN, obtained through the IRS, can be assigned over the telephone.
Q:What can be considered sources of income?
A: Sources of income include any compensation you receive, including sales, commission checks, prizes, incentives or awards.
Q:What can be considered a business expense?
A: Operating costs required to run your business are considered business expenses and may be deducted. To be deductible, a business expense must be ordinary (common in your field of business) and necessary (appropriate and needed). Expenses might include, for instance, telephone use, advertising expenses, wages, interest on business loans, etc. Business expenses must remain separate from all personal expenses. The biggest mistake people make is not keeping track of their deductions.
Q:Can I deduct business use of my home?
A: You can take a deduction from the business use of your home only if the “office space” is used exclusively and regularly as the principal place of your business, meaning you do the bulk of your selling in your home office.
You may also take a deduction for business use of your home for inventory storage. To qualify for this deduction, your home must be the only fixed location of your business, and the storage space must be separately identifiable, and used regularly and exclusively as storage space for the business. Figure the deductible by taking the square footage of space used for storage and dividing it by the yearly cost of maintaining all the square footage of your home, including utilities, repairs and upkeep costs.
Q:Can I deduct business use of my car and telephone?
A: For direct sellers whose business use of their automobile constitutes 50 percent or more of its total usage, two basic methods are used to establish your deductible: standard mileage rate or actual expenses. The standard rate is simpler to calculate–for every mile logged, 54 cents is deductible. With this method, however, you cannot deduct any of the actual operating costs, including depreciation of your car. To arrive at an actual expense figure, subtract the business portion of your car expenses from the total yearly expense of maintaining your vehicle.
The IRS recognizes two ways you use your auto for business: expenses for away-from-home travel, and local business transportation. While traveling away from home, you can deduct all reasonable and necessary travel costs. Local business transportation is considered as your day-to-day traveling expenses. Commuting (traveling between your home and a regular place of work) is a nondeductible personal expense. However, travel between two or more workplaces in the same day, or between your home and a temporary work location, is deductible. With automobile deductions, you must show the business miles you’ve logged, as well as the total miles you’ve driven during the year. Adequate records, like an account book or diary log, must be kept.
As for phone use, all business calls on a second phone line, or long-distance or call-waiting calls on a primary or secondary phone line, are deductible. You cannot deduct any charges (including taxes) for basic local services on the primary line in a home.
Q:Can I deduct meals and entertainment?
A: Business meals and entertainment are deductible if the expenses are ordinary and necessary to conducting business and can be proven as such. It’s a good idea to indicate on the back of all restaurant receipts what the particular business purchase was for, for which client it was made, and what business topics were discussed.
Q:How should I keep my receipts and arrange my files?
A: Your records must be permanent, accurate and complete. Keep your business expenses separate from your personal ones. One of the easiest ways to do this is to open a separate bank account or credit card used solely for business expenses. This saves you the time of separating out your deposits and debits from your bank statements.
Q:How long should records be kept?
A: General guidelines advise keeping records for at least seven years.
The last bit of advice we leave you with is this: if you’re venturing into the direct selling business, it’s a good idea to sit down with a Dallas CPA to discuss the tax implications and what you should expect. This is especially important if you find your business really starting to skyrocket and you’re generating a healthy income. At that time it may make sense to discuss whether incorporating your business is more advantageous from a tax perspective.