VITA: 01

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Introduction. Introduction and RulesMy Email: [email protected], My Office: SG 154Questions: Please keep questions relevant to the topic so we can get through all the materialAsk questions about personal situations after lecture, during one of the breaks or by emailIf a question is beyond

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1. VITA: 01/09/09 Lesson 9: Income from Business (Schedule C-EZ) Winter 2010 Kristina Shroyer

2. Introduction Introduction and Rules My Email: [email protected], My Office: SG 154 Questions: Please keep questions relevant to the topic so we can get through all the material Ask questions about personal situations after lecture, during one of the breaks or by email If a question is beyond the scope of VITA or extra complicated ask about it after the lecture, during one of the breaks or by email Try not to skip ahead – wait until we are talking about the topic you have a question about to ask the question Keep in mind when you are actually preparing returns you will first do the interview and then prepare the return You do not have to have this information memorized and can look up rules as needed Lesson 9: Business (self employment) Income Lesson 10: Capital Gains and Losses Lesson 10 Supplement: Cancellation of Debt for a Principal Residence Lesson 11: Retirement Income Lesson 12: Rental Income and Expense

3. Lesson 9: Self Employment Income Blank Forms for this Lesson As we go through this lesson you'll want to use some of the blank forms in Publication 4491-W for reference (blank forms start on Page 215) Form 1040 (page 215) Schedule C-EZ (page 241) Schedule SE (page 249)

4. Lesson 9: Self Employment Income Introduction In this lesson we're going to talk about business income from self employment how business income is reported How to determine if a taxpayer has business income or not How to determine if the taxpayer is qualified to use Schedule C-EZ or not How to determine how much business income (or loss) the taxpayer has How to report business income and expenses on Schedule C-EZ You'll notice I only mentioned Sch C-EZ in the lesson title and not Schedule C This is because Schedule C is out of scope for VITA Also note we are talking about self employment income We're not talking about income from an incorporated business or an employee Where is Self Employment Income Reported? See Line 12 of Form 1040 The Schedule C-EZ is used to support the number on line 12

5. Lesson 9: Self Employment Income What is business income? Business income (considered self employment income) is income received when goods or services are sold as a trade, business or occupation regularly with the intention of making a profit Fees are business income to a lawyer or other professional person (doctor, dentist, etc.) Payment a painter receives for services is business income In terms of this lesson we are talking about business income for self employed individuals which means the individual's business is not incorporated For purposes of Line 12/Schedule C we're talking about individuals that have income as a self employed person OR an independent contractor

6. Lesson 9: Self Employment Income How do you determine if a taxpayer has business income? First check the question on the Interview sheet Question #6 Does the taxpayer have a 1099-MISC? This is where self employment income over $600 from any one source is reported Even if the taxpayer did not receive a 1099-MISC if they received non-W2 income from a client/customer they need to report it and pay tax on it Many taxpayers may not think they are self employed because they get a W-2 and have a small side business Make sure and ask questions because these taxpayers are in fact self employed and have business income that needs reported If a taxpayer did not receive a 1099-MISC but did have self employment income ask for documentation of any income not reported on Form W-2 or Form 1099-MISC check stubs financial reports Example Form 1099 See page 49 for a 1099-MISC Example with self employment income Self employment income should be reported on line 7 of Form 1099-MISC but employer's do not always fill these out correctly so you may also see it on line 3

7. Lesson 9: Self Employment Income How to report self employment income? Self Employment Income is reported on either: Schedule C-EZ or Schedule C The profit or loss from the above is then transferred to line 12 of Form 1040 Self employment tax is then calculated on Schedule SE (we'll talk more about that in a minute) When you prepare the forms by paper you first fill out the Schedule C or C-EZ to determine if the taxpayer has a profit or a loss (see line 3 of Schedule C-EZ) then you transfer that profit or loss to line 12 of the Form 1040. The net profit is then used on Schedule SE to calculate the taxpayer's self employment tax When you prepare forms on the computer you just prepare the Schedule C and the amounts are transferred to the proper lines for you YOU STILL NEED TO DOUBLE CHECK ALL THE FORMS, DO NOT ASSUME THE COMPUTER IS CORRECT AND MAKE SURE ALL AMOUNTS ON ALL FORMS MAKE SENSE Remember we said for VITA Schedule C is out of scope and anyone needing a Schedule C should be referred to a professional tax preparer So the next step after determining a taxpayer has self employment income is to determine if the taxpayer is qualified to file a Schedule C-EZ rather than a Schedule C

8. Lesson 9: Self Employment Income Who can use Schedule C-EZ? Taxpayers with self employment income can only use Schedule C-EZ if they meet ALL of the following conditions: Have less than $5,000 in business expenses Use the cash method of accounting Have no inventory at any time during the year Inventory is simply items the taxpayer makes or buys for resale – inventory is not sold immediately – think of a retail store and all the clothing on the racks that is inventory Have positive net income (so they cannot have a loss) Operate only one business as a sole proprietor during the year So they can't receive some income from acting and other income from accounting because that would require two Schedule C's Have no employees during the year Are NOT required to compute depreciation Do NOT deduct expenses for business use of the home Do not have prior un allowed passive activity losses for this business – this would be a business the taxpayer does not actively participate in Let's look a little more closely at some of these terms Remember the taxpayer must meet ALL of these requirements in order to use Schedule C-EZ – if they do not qualify to use Schedule C-EZ it is out of scope of VITA and they must be referred to a professional tax preparer

9. Lesson 9: Self Employment Income Who can use Schedule C-EZ? (continued) Remember taxpayers have to meet ALL of the conditions listed on slide 7 Now we'll discuss a couple of the conditions in more detail To file Schedule C- EZ taxpayers must have less than $5,000 in business expenses What do we mean by business expenses? To be deductible expenses from a business must be Ordinary and necessary for its operation (to carry on the business or meet the purposes of the business) An ordinary expenditure is one that is commonly incurred by other businesses Even if the expense is infrequent for the taxpayer as long as it is common for other businesses it is an ordinary expenditure A necessary expenditure is one that is appropriate for a particular business Reasonable in amount It should be an amount similar to what businesses with the same purpose would incur

10. Lesson 9: Self Employment Income Who can use Schedule C-EZ? (continued) Remember taxpayers have to meet ALL of the conditions listed on slide 7 Now we'll discuss a couple of the conditions in more detail To file Schedule C- EZ taxpayers must use the cash method of accounting as opposed to the accrual method of accounting What do we mean by the cash method of accounting? Most sole proprietors and independent contractors use the cash method of accounting, it means expenses are reported when paid and income is reported when received Some sole proprietors may use the accrual method of accounting which means income is reported when earned rather than received and expenses are reported when used rather than paid Any taxpayer who uses the accrual method of accounting for their business cannot file a Schedule C-EZ and must file a Schedule C which is outside the scope of VITA

11. Lesson 9: Self Employment Income Who can use Schedule C-EZ? (continued) Remember taxpayers have to meet ALL of the conditions listed on slide 7 Now we'll discuss a couple of the conditions in more detail To file Schedule C- EZ taxpayers must NOT be required to compute depreciation What do we mean by depreciation? The cost of items that are expected to last more than one year (such as large machinery or furniture) generally cannot be expensed (deducted) all in one year. The cost of these items should be deducted over a period of years instead, think of a machine will last the company 5 years, 1/5 of the machine is deducted or expensed each year. If a taxpayer has costs of business that are depreciable items (machinery, equipment, furniture etc) the taxpayer is not qualified to file Schedule C-EZ but instead must file Schedule C – this is outside the scope of VITA so this taxpayer must be referred to a professional tax preparer.

12. Lesson 9: Self Employment Income How to Complete Schedule C-EZ? Let's look at Schedule C-EZ page 241of Publication 4491-W PART I of SCH C-EZ – General Information Line A is the principal business or profession (acting, sales etc) Line B is the Principal Business Code The tax software you will be using has a help screen you can use to find a list of the business codes, I believe they may also be in Publication 17 Line C is where you enter the name of the business If the taxpayer does not have a business name leave this blank Line D is where you enter the taxpayer's EIN (Employer Identification Number) if they have one Most Sch C-EZ businesses will not have EINs since they don't have employees (EIN is for payroll tax returns) Line E is where you enter the taxpayer's business address IF it is different from the address on the Form 1040 which in many cases it will not be

13. Lesson 9: Self Employment Income How to Complete Schedule C-EZ? Let's look at Schedule C-EZ page 241of Publication 4491-W PART II of SCH C-EZ – Figure Net Profit Line 1: Gross Receipts from Business Add together all amounts reported on Form 1099-MISCs for the business and any business income not reported on Form 1099-MISC Line 2: Total Expenses Enter the total of all business expenses the taxpayer actually paid during the year (so these expenses must have been PAID by 12/31/09) You can only deduct the portion of expenses that can be attributed to the business Examples: advertising, insurance, accounting fees, legal fees, office rent, travel expenses Meals and entertainment are only 50% deductible, you will enter them in full and then the software will account for the 50% Car and truck expenses – we'll talk more about this in a minute MAKE SURE ALL EXPENSES RELATE DIRECTLY TO THE BUSINESS…a taxpayer cannot deduct a meal unless it was for a business related purpose Phone lines The base cost of the first telephone line to a business cannot be deducted, but additional costs such as long distance incurred for business purposes can be deducted Read the example on page 9-4

14. Lesson 9: Self Employment Income How to Complete Schedule C-EZ? Let's look at Schedule C-EZ page 241of Publication 4491-W PART III of SCH C-EZ – Information on Vehicles Vehicle expenses can be calculated using the standard mileage method which uses the standard mileage rate (the taxpayer gets to multiply their business mileage by a pre-determined amount per mile – 55 cents per mile in 2009) or using the actual expense method (this is based on a percentage calculated using business mileage) to get a percentage of actual vehicle expenses (gas, depreciation etc) Since depreciation is out of the scope of VITA so is the actual expense method. If a taxpayer wants to use the actual expense method they must be referred to a professional tax preparer Part III will allow the computer to calculate the taxpayer's car and mileage expenses using the standard mileage method You must complete all questions in Part III Make sure you understand the difference between commuting mileage and business mileage Business miles do NOT include commuting miles between home and the taxpayer's business location or between the taxpayer's business location and lunch The calculated vehicle expenses based on the standard mileage rate should be added to the other business expenses on line 2 We'll talk about vehicle expenses in more detail in Lesson 22 (Business Travel Expenses)

15. Lesson 9: Self Employment Income Self Employment Tax Taxpayers must pay self employment tax on all net earnings from self employment of $400 or more Think of how your employer withholds social security and medicare taxes from your W-2 and pays that plus a match to the government, a self employed person must also pay social security and medicare taxes, this is self employment tax Look at Schedule SE on page 249 of Publication 4491-W This form is used to compute the self employment tax the schedule C-EZ net profit will be transferred to line 2 and the tax is computed and recorded on line 5, the amount on line 5 is then transferred to line 56 of Form 1040 (in the other taxes section), this is paid in addition to regular income tax We will talk more about Schedule SE in Lesson 28 – Other taxes Self Employed taxpayers get a deduction for ˝ of the self employment tax they pay on line 27 of Form 1040 We will talk about this deduction in more detail in Lesson 17 – Adjustments to income

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