Taxes
in the New Millennium
by
Jeffrey A. Babener
MLM Legal Attorney
©2002
April
is Around the Corner
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.
Lessons
From the Tax People
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.
A Social
Business
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.
Your Home
– The Business
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.
Everyday
Expenses
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.
Like to
Travel?
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.
Gifts –
to Business Friends
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!
Forms, Forms,
Forms
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.
All About
Hardware
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.
Record Keeping
— It’s a Must
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.
Be Creative,
But be Realistic
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.
For an in-depth analysis, please visit www.mlmlegal.com,
and also check out the Tax
Guide for MLM/Direct Selling Distributors (Jeffrey A. Babener, Legaline
Publications, 1-800-231-2162).
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
