Taxes in the New Millennium
by Jeffrey A. Babener
MLM Legal Attorney
Was it your plan that taxes would go down on your network marketing business in the new millennium? Was it your thought that President Bush’s $1 trillion proposed tax cut would help you out in April, 2001? Well, some things don’t change from century to century, and one of those is taxes on the network marketer.
One thing is clear from recent litigation brought by the IRS and the state of Kansas against a company called The Tax People, in Topeka, Kansas. If you plan to take deductions for your home-based business, the IRS expects that the business will be a real one. In The Tax People case, the IRS not only filed a lawsuit, but it also seized assets of The Tax People claiming that The Tax People falsely claimed that its new participants were automatically entitled to $5,000 in new tax deductions and unable to reduce their current tax withholding, giving them an immediate pay raise of $500 per month. The Tax People case also demonstrated that the IRS will chase after and audit networkers who it believes are taking suspicious tax deductions.
Remember, to be able to take advantage of tax deductions for your network marketing business, it has to be a real business. The IRS says that you can’t deduct business expenses unless you engage in the business on a “for profit” basis — not just as a “hobby business.”
How do you tell the difference? The IRS will look at one of two tests. The first objective test is whether you have made a profit in three out of five years. The second subjective test is whether or not you are prepared to demonstrate that you engage in your business in order to make a profit. Here, the IRS is looking at whether or not you carry on the business in a businesslike manner; the time and effort you put into the activity; whether you depend on income from it; your expertise in the business; how much profit the activity makes in the years it does profit; and other pertinent considerations.
Network marketing is a social business. You have to eat and you may as well have some fun and do it while you are recruiting or selling. This is one of those expenses the IRS keeps whittling away at, however. Your deductions are now limited to 50 percent of your meal and entertainment costs.
Beyond that, you must have records to substantiate your meal and entertainment deduction claims. In addition to the usual receipts you should keep for expense deductions, you will need to be able to document the substance of the business discussion, the business relationship, and who you had a meal with, or went with to be entertained. The business discussion has to be during the activity or immediately preceding or following it.
You can deduct the cost associated with your home office, but be prepared to show how you use it. Assuming you qualify, you can deduct a proportion of expenses related to your entire home, such as mortgage payments, insurance, utility bills and home repair. The space must be used regularly and exclusively for business. Second, you must use it for administrative or management activities of the business and you cannot have another fixed location for your business where you conduct substantial administrative or management activities.
You can deduct ordinary business expenses such as accounting fees, advertising fees, license fees, and so on. The tax advantage here is that many of your expenses may cross over between your home lifestyle and your business lifestyle, including telephone, cleaning supplies, office supplies, answering machines, audio and video equipment, fax machines, office furniture, and office decorations that improve both your home office and your house.
Do you like to travel? Does your spouse like to travel? Do both you and your spouse promote your network marketing business? The business travel deduction is a real advantage for networkers.
Of course, you are going to have to make a clear allocation between the business-related purpose of the travel and the vacation portion. Obviously, there is a gray line, and it will be in your interest to substantiate as much of the travel as relating to your network marketing business. Inside the U.S., all travel expenses are deductible when the trip is “primarily” for business. When traveling abroad, you must divide the travel expenses between business and vacation time.
Do you have friends and family who are also customers and business associates in network marketing? The probability on this point is high. A network marketer can convert gift-making, which might normally take place, into business gift-making, which is eligible for a tax deduction. Under IRS rules, you may deduct up to $25 for the cost of business gifts given directly or indirectly to these people. That should make you popular!
Almost every network marketing distributor agreement recognizes your independent contractor status, and so does the IRS. Because the IRS considers you to be self-employed, you are going to have to pay both income tax and self-employment tax.
If you have income greater than $500 a year, you will be making estimated quarterly tax payments as a self-employed individual. You will receive a Form 1099 from the network marketing company if you receive more than $600 in income or buy more than $5,000 of product or inventory. Your Form 1099 will be attached to your Schedule C, which in turn will be attached to your tax return. Your Schedule C will summarize your income and expenses from your network marketing business.
When it comes to these issues, you’re definitely going to need to talk to your tax advisor. You have some choices to make about how to deduct the acquisition costs of computer equipment and automobiles that are used for your network marketing business.
The IRS provides some very liberal limits on the amount that you can actually expense as a business deduction in any one year. (Of course, you are limited in expenses to the income from your business.) The other option is taking a depreciation write-off over a number of years for business equipment. Only your tax advisor knows for sure which is most advantageous.
The costs of running your automobile for your network marketing business are deductible. You have a choice of using the IRS’s standard cents-per-mile, or itemizing the automobile expenses, such as gasoline, repairs, maintenance, insurance, and depreciation. Obviously, you need to calculate what percentage of your overall car use is devoted to your network marketing business, and adjust the expenses to that percentage.
If you talk to our friends at the IRS, they will tell you time and time again that the most important aspect of claiming your expenses and deductions is keeping adequate records. The IRS will suggest that you keep a separate bank account, make a record of all business transactions, and retain all your records. Record keeping and substantiation are particularly important for deductions for travel expenses, entertainment expenses, and gift expenses. And the IRS will always tell you that a receipt is ordinarily the best evidence to prove the amount of expense.
If your network marketing business is making money, there is no reason why you should not be able to write off legitimate business deductions. Fair and honest deductions will save you a lot of money, but remember pie-in-the-sky or fantasy deductions may trigger audits and cost you money.
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad. His firm has focus on startup and emerging MLM companies. He has been adviser to such companies as Avon, Nikken, Discover Toys, NuSkin, Excel, Fuller Brush, Cell Tech, Kaire, Sunrider, Melaleuca, etc. He is editor of the industry resource internet site www.mlmlegal.com. He is a frequent lecturer and has been interviewed on the industry, and published, in many publications. Babener & Associates, 121 SW Morrison, Suite 1020 Portland, OR 97204, www.mlmlegal.com.
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