So many people today are promoting products that they are passionate about through direct selling. They are taking products such as Rodan + Fields, Beach Body, and Advocare that have helped them and that they enjoy and they are sharing them with their friends, family, and others. They are supplementing their income and in some cases replacing their income and more. They are able to build a business on their own terms that gives them the flexibility that they want in their lives. They are growing and gaining confidence that they can build a business. These types of businesses generally do not require a large up-front investment like a franchise would. My wife has even gotten in on the act. A friend shared Rodan + Fields with her and she liked the products and she is now sharing them with others.
These types of businesses, like any other, are subject to taxes. Owning a business, even a small one, adds a layer of complexity to the income tax return. Some taxpayers may have been able to prepare their own taxes, but now they may need to consult a tax professional to make sure that they report their income taxes properly and that they claim every deduction that they are entitled to so that they can minimize their taxes.
In most cases the direct seller will need to file a Schedule C on her tax return. On this form the income and expenses of the business are reported. The seller is generally classified as an independent contractor by their company rather than as an employee. If she earned more than $600 she will receive a Form 1099-MISC from her company that will report her gross income from the company. This amount will be reported on Line 1 of Schedule C.
The 1099-MISC only shows the income. She must also keep track of her business expenses. These could include supplies, cell phone, meals and entertainment, and mileage. A good way to track expenses is by using the app Expensify. Expenses can be managed from a smartphone. The seller can take pictures of bills and receipts with her phone. The app can also track mileage. If there is a home office used exclusively for business, a portion of home expenses can be deducted.
Unlike a W-2 employee who generally has taxes withheld, an independent contractor is responsible for paying her own taxes. She is responsible for self-employment tax and income tax. Self-employment tax is Social Security and Medicare tax. The rate is 15.3%. The income tax is paid according to the tax bracket that the tax payer is in.
Example: A direct seller received a Form 1099-MISC from her company with non-employee compensation of $10,000. She had $2,000 in deductible expenses. This would give her net income of $8,000. The self-employment tax on this income would be $1,224. If the direct seller is in the 25% bracket, the income tax on $8,000 of income is $2,000. Therefore, total amount of tax for $8,000 in income is $3,224.
As you can see in the above example, taxes take a big bite out of Schedule C income. In my experience, many people are very surprised the first year they are self-employed. They may have always been on a W-2 and had taxes withheld and received an income tax refund. They did not realize how much their taxes would be and they spent all the money they made, and in some cases, owed thousands of dollars on April 15 and they did not have it. It is important have the discipline to set aside money for taxes. A good rule of thumb is to set aside a percentage of sales for taxes as the money is received. It may be helpful to put that money in a separate account. The percentage will vary depending on the level of expenses and the tax bracket the taxpayer is in. The money can be paid to the IRS and state by quarterly estimated payments.
Please contact me at email@example.com if you have any questions or if I can help you by setting up a simple accounting system for you or preparing your income tax return.