Organize Your Finances and Prepare for Taxes
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Disclaimer: Before we start let me say that I am not a lawyer or accountant. As such I cannot guarantee the accuracy of the information provided. I will be sharing with you information about how we organize our business finances with the hope that it will help you get started. None of this information should be taken as legal or tax advice. You should consult a professional lawyer or accountant to understand your tax and legal obligations based on your specific situation.
Congratulations! You have decided to get started in direct sales! That officially makes you a business owner! It is such an exciting time! Being a business owner has many advantages hourly or salary employees do not enjoy. For example, a portion of your cell phone and internet bills (things you would be paying for whether you have a business or not) are now business expenses that will offset the income you make from your business. You may also be eligible to take a home office deduction if you have dedicated working space or inventory storage areas in your home. All of these help lower your tax burden.
To fully get these benefits of being a business owner it is important to get your business finances organized. Below we’ll share the things we’ve learned in our entrepreneurial journey and how we organize and keep track of our business finances and prepare for tax season.
Separate Your Business and Personal Accounts
We list this first because it makes everything else so much easier! Keeping track of your business expenses is much simpler if you use separate bank accounts for business and personal use. Even if you don’t decide to get an actual business bank account at this time, you can still use a separate personal bank account exclusively for business activities. We have a personal checking account we use for personal deposits and expenses and a separate business checking account for business deposits and expenses. Do the same thing with your credit cards also. Use one for personal expenses and one for business. It is so much easier to keep track of your business income and expenses if those transactions are not intermixed with all of your personal transactions.
Keep Track of Your Income and Expenses
Preparing for tax time will be easier if you keep track of your income and expenses throughout the year. We recommend doing this monthly. When we first started we used a simple Income and Expense tracker. Eventually, as our business grew, we decided to move to Quickbooks Online for keeping track of our business finances. Quickbooks is the industry standard when it comes to keeping track of business finances. It also easily generates financial reports (profit and loss, balance sheet, etc.) to help you understand how your business is performing. It also comes with a handy mobile app where you can enter your expenses on the go and snap pictures of your receipts. We use the Simple Start level for Quickbooks Online and it does everything we need. If you are a new Quickbooks user you can buy a 1 year subscription on Amazon for a big discount off the regular price for your first year!
Record Your Mileage
The IRS has a mileage allowance (54.5 cents per mile for 2018) for business owners. Essentially you get to deduct from your business income 54.5 cents per business mile you drive. Depending on how much driving you do for business this could be a big savings. In order to take the deduction you have to keep a mileage log. The Income and Expense Tracker mentioned above has a tab to manually track your mileage. This works great if you aren’t doing too much driving for business. If you do a lot of driving you may want to consider TripLog (this is the app we use) to help you automatically track and categorize your miles.
Your parent company will be charging, collecting and sending sales tax to the proper agencies. You do not need to keep track of sales tax or send any money to your local tax agency. When you buy product to keep as inventory or sell at vendor events, you will be paying sales tax when you make the initial purchase. When you sell your inventory you should charge your customers sales tax to reimburse yourself for the sales tax you paid when you purchased the inventory.
Preparing for taxes
Taxes are a scary thing for some people, but if you keep your finances organized throughout the year then filing taxes becomes a lot less intimidating. Below is the list we use at tax time to prepare for filing. If you’d like a condensed version of this info in a worksheet format, enter your name and email address below and we’ll send you a copy!
1) Gather your 1099-MISC forms
You will receive a 1099-MISC from your direct sales company if they pay you more than $600 during the year. If you earned less than $600 you will still need to report it as income on your tax return, but you will not get a 1099-MISC. If you earned any incentive trips with your company the amount on your 1099-MISC will be higher than the commissions and bonuses you earned. This is because the value of any incentive trips is considered income and will be reported on your 1099-MISC. The 1099-MISC form is mailed by January 31st from your direct sales company.
2) Gather your 1099-K forms
1099-K forms are sent from payment processors like Square or PayPal if you have over 200 transactions and over $20,000 in sales. They are also mailed by January 31st.
3) Generate a profit and loss statement
A profit and loss statement (or P&L) sounds like a fancy form, but it is really quite simple. The top of the form has all your income and the bottom has all your expenses. Then you subtract your expenses from your income to figure out your profit or loss. Our Income and Expense Tracker helps you make a profit and loss statement and categorize your expenses to help with tax filing. Or if you are using accounting software like Quickbooks, you will be able to generate a P&L using the Reports function in the software.
4) Calculate your end of year inventory
You are required to report the acquisition cost (amount you paid) of your inventory for taxes. This can end up being tricky to figure out for a lot of direct sellers because the cost of your inventory likely fluctuates. Some inventory you purchase at a discount off the retail price, some you probably get as hostess rewards for free or a different discounted amount and some items are even gifted to you as a perk from your company. How are you supposed to know how much you paid for the inventory you have left at the end of the year? We calculate the cost of our inventory by first determining what the retail value is of the inventory we have left at the end of the year and then multiplying that by the average percentage discount we pay for product. Between the free, discounted and regular price items we keep on-hand for vendor events and local in-person sales it averages out to paying about 20% of the retail price for our inventory. For example, if the retail value of our inventory is $1,000 the acquisition cost of that inventory is estimated to be $200 ($1000 * 0.20 = $200).
If you only have one or a few products you sell and keep on hand, and the cost of the product is consistent every time you purchase it, you may know exactly how much you paid for your inventory and can report that amount. In our case there is a catalog of hundreds of items and the cost of the items vary so we use this average cost method. Whatever method you use to determine the cost of your inventory, make sure you are consistent and continue to use that method going forward.
5) Fill out your mileage log
Finish filling out that mileage log you were keeping throughout the year so you know how many business miles you drove last year. If you are using software like TripLog to automatically track your miles you should be able to download a summary report that will show you how many personal and business miles you drove during the year.
6) Gather your home office expenses
To be eligible for the home office deduction at least one of the following must apply:
- You exclusively and regularly use part of your home as your principal place of business
- You exclusively and regularly use part of your home as a place where you meet customers
- You use part of your home on a regular basis for storing inventory or product samples
If you are eligible for the deduction the expenses you will need to gather are:
- Direct expenses – These are expenses exclusively for the home office and are fully deductible. Examples include things like repairs and maintenance only in the office (fixing a light, etc.)
- Indirect expenses – These are expenses that apply to the whole home and not just the home office. You will only be able to deduct a portion of these expenses. Examples include:
- Rent (if you do not own your home)
- Mortgage interest and property taxes (if you do own your home)
- Utilities (gas, electric, etc)
- Home maintenance expenses for the entire home (pest control, cleaning fees, etc.)
The amount you get to deduct on indirect expenses is calculated based on the percentage of your home that is used for your home office. For example if your home is 1000 square feet and your office is 50 square feet and you use 50 square feet for storing inventory the total square footage used for your home office is 100 square feet. The percentage of indirect expenses you will be able to deduct is 10% (100 sq ft / 1000 sq ft = 10%).
7) File your taxes
Most direct sellers run their business as a sole proprietor. By default, once you have any income from business activities according to the IRS you are a sole proprietor. Your business income and expenses will get reported on Schedule C and your profit or loss will roll up to your Form 1040. Your profits from the business will be subject to self employment tax so it is important to set aside money throughout the year to cover those taxes. The amount you need to save will vary by state but a typical recommendation is to save 25% of your profit to cover taxes.
Remember those 1099-MISC and 1099-K forms we talked about? Your business income should add up to the amounts reported on these forms or more. The IRS gets a copy of these forms so they know your business generated at least that much income. If you report a lower amount the IRS will likely reach out to you with an inquiry to figure out why. No one likes the IRS getting all up in their business so make sure report your income accurately!
For awhile we did our own taxes using TurboTax Home and Business. It walks you through a lot of simple questions and fills out all the necessary tax forms for you based on your responses. For anyone that wants to file taxes themselves I highly recommend giving TurboTax a try. Now that our business has evolved, grown and become more complex we outsource tax preparation to an accountant.
Do you have any other tips or recommendations? Let us know in the comments below!