Running a business is complicated in and of itself. There are all kinds of things you have to keep track of including taxes. There are many common mistakes made when it comes to taxes and on this episode of the podcast, Scott is talking with his friend Josh about the common questions that come to him when it comes to business text questions. Being a CPA, Josh has the actual answers you need in order to do things legally and ethically. You can hear all of these common questions and their answers on this episode of the podcast.
Are you calculating your product inventory the RIGHT way for tax purposes?
Many people think that in order to calculate their taxes correctly when it comes to inventory they simply need to add up how much they have spent on products during the calendar year. Scott's guess today is a certified public accountant and he says that is actually not the right way to do it. You will find up providing wrong figures to the IRS if you do so, and you could be liable for a much larger payment, plus penalties by doing it. On this episode, you were going to learn the right way to calculate inventory for tax purposes.
Is an IRS audit something you should be afraid of?
When you hear the phrase, “tax audit” it may cause you to break out in a cold sweat. But do you really need to be so concerned? What is the likelihood that you were really going to be audited? And if you are, which kind of audit is it that you should be concerned about? And this great conversation with a certified public accountant you were going to hear about the different kinds of audits, what each of them really is about, and what you should do if you are audited. It's a great episode to dispel a lot of the myths that are floating around in the business community, so make sure you take the time to listen.
What meals and entertainment are deductible?
Many people who run a business have been told that they can deduct meals and entertainment that have to do with their business with no problem. But is that entirely true? When this episode of the podcast a certified public accountant is going to tell us that you actually only get to deduct 50% of your meals and entertainment, and you can only do that if those are directly related to a business activity of some kind. If you want to hear the full story on this important issue, make sure that you listen. It could save you a lot of money in the end.
What business entity is best for your business?
There's a good deal of confusion about which business entity you should choose for your business activity. Should you be a sole proprietor? What about an LLC? Or maybe an S corporation or C corporation? If you're confused by all of these possibilities you are not alone. On this episode of the podcast, you will hear the definitions of each of these, what their advantages are, and how you should go about choosing the one that is right for you and your business. This section of the podcast alone is worth the time it will take you to listen.
OUTLINE OF THIS EPISODE OF THE AMAZING SELLER
- [0:09] Scott’s introduction to this episode!
- [3:19] How to deal with inventory as a business expense – the RIGHT way.
- [11:29] Turning common personal expenses into business deductions.
- [13:15] Home office space – how do you deduct it as a business expense?
- [16:14] When the IRS contacts you for an audit – how does it happen?
- [19:10] What meals and entertainment are deductible?
- [21:06] Bookkeeping issues: How should you keep your records?
- [25:41] A good rule of thumb for withholding federal taxes.
- [27:20] The various business entities you can do business as.
- [34:20] Can an S-corp be backdated to the beginning of your LLC creation?
- [38:40] The issue of sales tax: How should you handle it.
TRANSCRIPT TAS 251
TAS 251 : How to AVOID Common Tax Mistakes in Your Business (CPA Guest)
[00:00:09] Scott: Well hey, hey what’s up everyone! Welcome back to another episode of The Amazing Seller Podcast. This is episode number 251 and today we’re going to be talking about how to avoid common tax mistakes in your business. I’m having our good friend Josh Bauerle a CPA on as a guest to answer…
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…these questions and give us some advice. Here’s the deal, since having him on the podcast which was back on episode 143… If you haven’t listened to that episode you probably should. It was a great episode just before the first of the year, last year, so we did it before tax time. He just dropped some really, really great nuggets for us to really understand before going into the tax season.
Now is even better than last year because well you have time yet to really prepare your books and all of that stuff. I wanted to have him on because since that episode, he’s gotten tons and tons of emails and requests and new business relationships with some of you and a lot of questions. A lot of questions came in from an Amazon or an ecommerce seller and I wanted to have him back on and say, “Hey Josh what are the common things that people need to know that we need to make sure that they know before thinking one thing?” Before they actually go down this road let them have a good understanding of like how inventory works on your taxes.
Bookkeeping basics, to keep the books straight so this way here you’re not just scrambling at the last minute. Sales tax, we touch on that. Business entities, we talk about that again. All of the different things that he has seen coming through the emails and the communications working with Amazon and e-commerce businesses now it’s different.
[00:02:00] Scott: It’s different than just general business because there’s inventory involved. And there’s sales tax involved and there’s all of these other elements that don’t necessarily pertain to every online business. Wanted to have him back on, I’m really excited that he’s on. He again dropped some really great knowledge bombs here for us.
He’s just a great resource, a great friend. Also wanted to remind you that we’re going to have all the show notes, the transcripts, all of that stuff will be hooked up at this page or on this page, theamazingseller.com/251. Again that’s theamazingseller.com/251. The last episode that he was on was 143. Again I will link that up in the show notes and you can always find him at cpaonfire.com, again that’s cpaonfire.com. Just a great guy, if you have any questions definitely reach out to him. He’s always more than willing to answer any questions that you have.
What do you say, let’s jump into this great conversation that I had with Josh Bauerle all about inventory bookkeeping, sales tax, business entities and everything else in-between. We go through a lot of details, a lot of discussion here and it was a lot of fun and I think you’re going to learn a lot from this conversation that I had with my good buddy, Josh Bauerle. Enjoy the show.
[00:03:25] Scott: Hey josh welcome back to the podcast. What’s going on man? How are you doing?
[00:03:32] Josh: Good thanks for having me back.
[00:03:34] Scott: I’m excited to have you back on and hopefully the internet connection stays because I know you have some storms there. You always have storms it’s seems, when we Skype.
[00:03:43] Josh: I think that’s taxes, right? Discussing taxes causes storms.
[00:03:47] Scott: I think you’re right. I think whenever we talk about taxes something the government probably has something that it just starts making everything interfere with. “Do not tell them the information.” I wanted to have you back on because there’s a lot of questions that go into just when running a business in general. Now that we’re talking about ecommerce and we’re talking about selling on Amazon, we’re talking about sales tax, different entities. I had you on the podcast back on, actually all the way back on 143.
Anyone that wants to listen to that episode, check that out on theamazingseller.com/143. That there we talked about some killer tax tips. Also we talked about business entities. We’re going to readdress the entity thing but then also I really want to hear what you’ve been hearing. And maybe answer some questions that are commonly being asked to you. Especially since being on the podcast, now you got a lot of people that are coming to you for advice when selling on Amazon. Well where do you want to start? Where do you think we should to start?
[00:04:51] Josh: Let’s start with the whole business expense thing and how that ties in especially to an Amazon business, cool?
[00:04:59] Scott: That’s perfect, you go ahead man.
[00:05:00] Josh: As you said first of all, we get a ton of questions from your audience. You have an amazing audience and we’ve gotten to the point where we almost had to create a division that basically specializes in Amazon and ecommerce areas.
[00:05:13] Scott: Nice. TAS baby.
[00:05:13] Josh: We’re getting the same kind of questions over and over again. One of them is always, “What can I deduct my business? What’s a business expense?” Obviously that’s a little bit of a generic question and it’s tough to just say, “Oh yeah x, y, z is a business expense.” Really when it comes down to it, anything that you’re spending money on that provides a benefit to your business is probably going to be at least a partial business deduction. There’s definitely few things that I think are unique to the Amazon space. The one area that we see over and over and over again causing the most confusion by far is the topic of inventory.
[00:05:58] Scott: That is a good one. That is a good one.
[00:06:01] Josh: It would seem to be common sense. Okay, I bought $20,000 worth of inventory, I have a $20,000 tax deduction. That’s how most tax deductions work. You go and buy a $5,000 computer system and you potentially have a $5,000 deduction. Inventory is not quite the same way. Inventory gets expensed on what’s known in the accounting world as the accrual method. This doesn’t matter if your overall business is taxed on the cash method. Inventory still works on accrual. What that means is inventory does not become an expense until it’s sold. We have people all the time, of course it happens a lot when we don’t get to talk to them until after taxe season.
Then they say, “Oh yes I’m not going to show much profit I bought $50,000 worth of inventory on December 31st, I’m all good.” Then we have to break the bad news and say, “Yeah most of that $50,000 is not a deduction.” Because again it’s not a deduction until it’s sold. If on December 1st first you bought $50,000 worth of inventory, by the end of the month you had a good Christmas season, you sold $40,000 of that inventory, the remaining ten is not a deduction. The biggest mistake we see people making when they’re doing their own taxes in this space is deducting inventory.
[00:07:19] Scott: That’s a big one.
[00:07:20] Josh: It is. That’s when the IRS… They’re not going to be happy with you on that one if you deduct a lot of inventory. You’re not allowed to do that. There’s three things I want people to track, to be able to know how to deduct this inventory. You always have to know what the beginning value of your inventory was at the beginning of the year as of January 1st of that year. When we say value, we’re talking about the cost you paid for. If you paid $50,000 that is the value of your inventory. Then you need to know how much inventory you purchased throughout the year. Finally, you need to know the value of the inventory that’s left at the end of the year, as of midnight on December 31st. Just walk through, real quick example here, let’s say as of January 1st 2016 you had $100,000 worth of inventory that was unsold.
Let’s say that throughout 2016 altogether, you purchased $100,000 worth of inventory. That means, throughout this year, you started with $100,000, you bought $100,000 more. Basically $200,000 worth of inventory is credited this year. Now you get to the end of the year, you do an inventory count on the end of December 31st. You didn’t even go out for New Year’s Eve, you just did the inventory. You see that you have $50,000 left in inventory. You had $200,000 worth of valued inventory throughout the year. You have $50,000 left at the end of the year. Your inventory expense, what they call cost of goods sold is $150,000. Makes sense?
[00:08:53] Scott: Yeah. Yeah.
[00:08:56] Josh: It’s a super confusing topic. I know a lot of people are saying, “Nope that’s not fair. I am not doing that. I’m deducting all my inventory.” Unfortunately it’s what the rule is. I’ve heard some people say, “Don’t call it inventory then, call it office expense.” It doesn’t quite work that way.
[00:09:13] Scott: If someone starting four months into the year that’s basically going to still apply from whatever you basically purchased. An easy way to think about this like if you started with a certain number, you don’t use that unless that’s been sold even though you started with that. It always comes really back to zeroing it out in a sense to where you can say, “Okay I sold 1000 units. Those 1,000 units cost me five bucks a piece” Do the math, deduct it, boom, done.
[00:09:50] Josh: Exactly, that’s the bottom line. The three numbers you’ll need to put on the tax return are beginning, purchases and ending. The bottom line is how many did you sell and at what price did you buy it for?
[00:10:00] Scott: Exactly. That goes down into everything as far as like… Now shipping to get that item to us, that’s still part of that per unit cost, correct?
[00:10:12] Josh: Yeah exactly, we can do shipping, anything that went into getting that inventory to you is a part of that cost of goods sold.
[00:10:20] Scott: That’s where you’re going to figure out that your price is five bucks. It might have been $4 for the item but a buck to get it here so that’s five bucks. That’s what it cost you and that’s why it’s important to know how much it cost you to get that one item created and actually get it into the warehouse, is really what it comes down to. That is a big one. So you’re seeing that and you’ve seen that obviously even from last tax year to this tax year where people are still under the impression that I just gave $20,000 off to someone. I’m immediately going to take that as a deduction and that’s not the case.
[00:10:52] Josh: That’s how you record it in your own books and that’s fine. However you want to record it for your books for tracking your expenses and such but when it comes to taxes, unfortunately it’s not a deduction until it’s sold.
[00:11:06] Scott: The way that I would look at it too is if you are just doing it on a very basic level, if you take it like a month let’s say, and you sell, again 1,000 units. Well then for that month when you’re doing your numbers for that month, you’re going to take those 1,000 units even though you might have 5,000 in inventory, you’re only taking those 1,000 that you actually sold and then deducting whatever it cost you for those 1,000 units on a basic level.
[00:11:33] Josh: Exactly that gets moved into cost of goods sold.
[00:11:35] Scott: Okay, cool. What else you got?
[00:11:39] Josh: Just to stay a little bit more on this theme. If we want to talk about something common. Everyone wants to know, “What are the common business deductions I’m missing?” In my experience, the biggest thing when it comes to a business is finding a way to turn some of these maybe expenses that were personal expenses and maybe still are partially personal expenses and turn them into business deductions. What I mean by that is you had a cell phone longer before you had this Amazon business, right?
[00:12:05] Scott: Yes.
[00:12:05] Josh: But now you’re calling suppliers, you’re calling up Amazon on those issues, whatever. You’re using your cell phone for your business. Now, it is an expense in your business. This used to be something that a lot of people said, “Okay try and figure out a percentage. Use your cell phone 50% for business, 50% for personal. Deduct that percentage in the business.” There’s been some recent IRS court cases where they’ve determined that if you used your cell phone for your business and it is absolutely needed for your business, it’s a business deduction whether you’re using it personally as well or not. The person that actually won this a case actually deducted their entire family plan and still won the case.
I wouldn’t have any issues if someone wanted to deduct their full family plan. If you had a family of 10 and we’re going to write a $10,000 expense for cell phone and you have a $20,000 business, you might have some issues there. Always use common sense with any of this stuff. Yeah, cell phone’s a big one. Home internet, same thing. Obviously, the home internet is absolutely crucial. You can’t have an Amazon business without a home internet. I would have no issues whatsoever deducting 100% of that regardless of how many people you have in the house using it. Regardless of if you’re using it for personal, you need that for your business it’s 100% necessary. That’s a full deduction.
[00:13:18] Scott: Okay. What about something like your home office? I’m sitting in a room right now that’s probably about I don’t know, 14 by 14 in size. I’ve got all my stuff in here and this is where I work. What is that doing for me personally? I know the answer but I want you to go through it.
[00:13:40] Josh: They do allow what they call ‘a home office deduction’. The first starting point here is it has to be a room that’s used solely for business. There’s none of this okay I’m taking my kids bedroom and putting a desk in there and now it’s my home office. This has got to be a room that you’re using solely for business. Here’s where it gets interesting for ecommerce and Amazon sellers is if you have a room or a garage or a basement that you’re using solely to stock inventory, now that could be a home office as well. What you’re looking at here for tax deduction, you have one of two ways that you can go.
If you’re a pretty detailed person and you can keep good records and you can track all of this stuff, we can actually take and look at it and say okay you spent $5,000 on utility for your house for the year. You spent $10,000 on mortgage interest, $1,500 on property taxes, everything involved with your house basically. Look at it, your office is 10% of the square footage of your house so we can deduct 10% of all those costs on your taxes.
[00:14:38] Scott: Got you. That’s helpful.
[00:14:41] Josh: Then there’s other people out there who say, “There no chance I’m going to track all that stuff.” For those people the IRS actually made it a little simple and said, “All right $5 per square foot,” call it good.
[00:14:51] Scott: Oh, nice. Okay. That makes it easy. Again if you’re not doing this you’re just, to me leaving money on the table because every deduction is going to… Honestly, again like we said we’re doing this honestly and ethically. We’re not saying anything that wouldn’t be up to standard as far as the IRS goes. Like me I’m in my home right now but I work here 100% of the time. Like you said, I do have storage space that has some boxes. If I have someone that I’m paying for that, that’s a deduction. Anything that you can I guess look at as there’s a part of your home that’s being taken up by your business, then that’s part of your expense.
[00:15:34] Josh: Yeah, exactly and obviously you want to be careful making sure that those do have a few more rules and other deductions but yeah, if we can meet those obligations of it’s used solely for the business, absolutely there’s a way we can deduct that. The other thing I’d say with the home office, I read this sometimes on the internet and I get clients that ask all the time and say, “My old CPA said that’s a major red flag and I shouldn’t take the home office deduction.” First of all there’s been zero proof that anyone that takes a home office deduction is audited more often than someone that doesn’t. Second of all, our philosophy is always who cares. If we’re doing your taxes the right way and we’re confident, the deductions you’re taking are legit, then we invite the IRS to take a look. It might be a little bit of a pain in the butt to send them what they need but at that point they can see that you’re doing things legit, they’re not going to bother you again.
[00:16:21] Scott: I like that. There’s something else too I want to address real quick while we’re on that topic because that’s like, “Oh my gosh what happens if I get notified?” Like of an audit or this that and the other thing and you were on John Lee Dumas’s podcast, EOFire and you were doing the income report and all that stuff. There was one of them that you guys were talking about and you had actually said that when they do contact you, if they contact you, they’re going to usually contact you in a specific way. Can you maybe talk about that real quick just so we can clear that up? I know it’s a scary thing for a lot of people. They see something, like, “Oh my gosh, here we go,” kind of thing. Maybe you can address that.
[00:17:01] Josh: That was actually a three part series on EOFire. We got a lot of emails thanking us for that because people are terrified of this audit thing. They hear that self-employed people are audited more often, they get more terrified. There’s a few things you need to understand about this big scary audit word. The first thing is it’s incredibly unlikely to happen to you. Last count I think 2013 is the last numbers they had it was under 1%. If you’re making less than $250,000 a year that number goes down even further. It’s probably not going to happen to you. Second of all, if you are audited there’s three different types of audits.
One is what they call a correspondence audit where they mail you a letter and say, “Hey Scott, you claimed $10,000 in meal and entertainment expenses. Could you send us a little documentation on what went into that?” That’s what almost every audit’s going to be. The other two audit’s a little more scary where you have to go into their office and they’re going to question more parts of your tax return or they’re going to actually come into your place of business or sometimes even your home and look at things directly. For almost every person listening to this, if they are ever audited, it’s going to be a correspondence audit. It’s going to be a simple letter in the mail asking for maybe a little bit of proof, maybe a little bit of further documentation on something that you’re claiming on your tax return.
[00:18:13] Scott: Now what if I get a phone call? What if I get a phone call? I think that was a good point you brought up.
[00:18:18] Josh: The IRS will almost never, almost never contact you via phone. If you have someone contact you that says they’re from the IRS and they have a weird accent, and they’re telling you you’re about to go to jail if you don’t pay these taxes, it’s not true. Actually I have a funny tape recording. I’ve recordings of someone that called a client and played along with it to see what happened. The IRS is not going to call you by phone. They’re not going to demand payment by phone. The only time that they ever might try to call you is if they’ve been mailing you letters and it keeps getting send back as an undeliverable address and they have no way to get a hold of you. That can happen but then it’s going to be a very, very informal phone call of, “Hey we’re trying to contact you, can you give us an update of the address,” blah blah blah.
[00:19:00] Scott: Okay. Again I just wanted to throw that out there, just kind of came to me that you guys were talking about that. I know that that’s a scary thing. It’s like when you get a letter and it’s addressed IRS you are like, “Oh no,” or if you get a phone call or whatever. An email too I’d be careful, again because a lot of times there’s some fishy things going on out there where people are trying to get you to think that the IRS is contacting you and if you don’t contact them then something bad’s going to happen. Then you put in your information and then they get your information and then you’re screwed. We don’t want that to happen so that was good. We talked about deductions, we talked about your office. Let’s talk about meals again real quick because you did bring that up and I think that’s another good one that people either they don’t take those or they take too much. Let’s talk a little bit about that.
[00:19:44] Josh: The IRS does allow you to deduct what they call ‘meals and entertainment’ if it’s used for your business purpose. Where this originally started is if you think of old school businesses where people would go out and have those three martini lunches and whatever. That’s how this came up where they go and talk business. Maybe it doesn’t apply as much to an online business but I’m sure you’re still having times when you’re going out there and you’re meeting with people to discuss business in some way, whether it’s a colleague and you guys are sitting down and discussing what you’re doing and what he’s doing and how you can help each other or if you’re out of town. You went to a conference and you’re going to lunch every day. All these kind of meals are deductible on your tax return. There’s one thing you have to now here, only 50% of the meal is a deduction. That doesn’t matter whether you pay just for yourself, whether you pay for you and five other people at the table, it’s still a 50% deduction.
[00:20:41] Scott: Got you.
[00:20:41] Josh: What you want to do, the one mistakes that half people make when they find that out is they’ll give their CPA the number with 50% already taken off. Then what’s going to happen is their CPA is going to assume that that’s the full amount and take another 50%.
[00:20:54] Scott: Okay, yeah, yeah.
[00:20:55] Josh: Always give it to your CPA with the full 100% on there and tell say, “Hey, this is 100%, can we take 50%?” Whatever.
[00:21:03] Scott: Okay, that makes sense. Yeah because then you’d only get 25%.
[00:21:07] Josh: Exactly. That’s why my math’s working out.
[00:21:11] Scott: All right, cool. What else you got? You got anything else for us?
[00:21:15] Josh: Yeah, let’s talk a little bit about bookkeeping because we’re talking about all these expenses. The big thing is you have to know what they are come the end of the year and especially new businesses we’re seeing them a lot of time thinking that they can have a shoebox full of receipts and go through them come January and have it all ready to go and it’s probably not going to happen. I used to say a spreadsheet it’s just fine and to some people that it is but the more working with people give some type of accounting software, whether it’s one of the big guns like QuickBooks online or Zero or… What’s the one you use?
[00:21:49] Scott: I use Wave. I like that one a lot.
[00:21:51] Josh: Yep, Wave app is good I think it’s a little bit cheaper even, GoDaddy.
[00:21:58] Scott: FreshBooks is a good one I think.
[00:22:01] Josh: FreshBooks can be. They’re good for invoicing, sometimes not as much for accounting but…
[00:22:06:] Scott: I haven’t used them but that’s just from what I gather. I haven’t used FreshBooks, I’ve used QuickBooks and I’ve used Wave apps. I like Wave apps the best honestly. Honestly, Wave apps is actually free unless you want them to do some of the work for you. You maybe see a banner ad or something here or here but I love it. It’s a very robust system. It doesn’t connect directly to your ecommerce store which I believe Zero does so that maybe something that people want to look into but for me personally, Wave has been great.
[00:22:36] Josh: Yeah, and like you said, it depends on what you’re looking for so Zero’s the one that we’re typically using with clients and that’s simply because it does have more features of… There’s plugins for Amazon and plugins for all these inventory management systems and all that kind of stuff. If you just have basic stuff going on, Wave is perfectly fine. The only thing that I would say you need to look out when it comes to finding some type of accounting software, one, make sure it’s cloud based. Don’t go by QuickBooks’s desktop, no one’s going to be able to work with you on it. The other thing is make sure something that can sync directly to your bank accounts.
[00:23:11] Scott: Okay.
[00:23:13] Josh: Most of them will. I see Wave does that, right?
[00:23:16] Scott: Yep.
[00:23:17] Josh: Yeah so if you have a small bank, you might have to search a little bit to find someone that can connects with that bank but that will take so much time off your plate by… What is going to happen is if you have your business bank account Bank of America is going to sync right up with them. Every time you use money or put money into the system, it’s going to show up in Zero or QuickBooks or Wave and all you have to do is go on there and label what it is.
[00:23:39] Scott: Got you.
[00:23:40] Josh: So it’s going to take significant time off it. The one thing I will say when it comes to bookkeeping is if you’re someone that knows is not going to do this yourself, either you don’t know how, you’re not going to take the time to learn it or you just feel like you can better spend your time somewhere else, pay to outsource this. There’s some low-end companies, Bench, they’re up to like 135 bucks a month. It’s not going to be a perfect system but they’ll get the job done for you with only a few minor adjustments you have to make. We started offering it solely because of the Amazon people we had that needed this book keeping and weren’t getting a good system, they can range anywhere from $250 to $500 a month which I know if you’re just starting that sounds like a lot of money but I’m telling you 2 to 3 years down the road when you got $0.5 million or a $1 million coming through you’re not going to want to touch this stuff yourself.
[00:24:30] Scott: Yeah, I agree.
[00:24:33] Josh: You either got to make the commitment that you’re going to do it yourself or you have to outsource it.
[00:24:39] Scott: That’s a great point and I think as much as we don’t want to do it, it’s important to keep things organized so that way when it does come time it’s not such a task. Like you say, you don’t want to have the shoebox of receipts and then have to enter them all at once. I’ve gotten into the routine as well like with being able to schedule it that that’s the time that things get inputted if they need to be inputted because let’s face it, some receipts that you get are not going to be inputted into the system unless you have it done. The other thing is two, if you have a credit card that you’re using, I’m not sure if any other programs will do that. Do they do that where they integrate with your system?
[00:25:24] Josh: Credit cards you mean?
[00:25:25] Scott: Yeah.
[00:25:25] Josh: Yeah all the main ones will… QuickBooks, Zero, Wave will all integrate with your credit card as well as your bank accounts, PayPal as well.
[00:25:34] Scott: PayPal as well, okay good. Staying organized, making sure you do all that stuff, it’s important that you do it so that way there you can give your accountant or your CPA the necessary things that they need to be able to input that for you so you can see what you got to pay in taxes. What’s a good rule of thumb, I know this is going to range but I want you to give us some estimates or some ideas like for someone that is doing $50,000 a year in, not just revenue but profit. If you’re your own business you got to start taking some federal tax out. Do you have an idea of what you should be taking out every week, it’s like you’re getting a paycheck and you’re taking it and putting it over into a little kitty?
[00:26:21] Josh: Yeah, so some of this depends on what type of business you are, what state you’re in etc. All that aside, if you can set aside 20 to 30% of your profits, you’re going to be in pretty good shape come tax time.
[00:26:33] Scott: Okay.
[00:26:34] Josh: Obviously some people have 10 kids to claim, some people have zero so it all plays a part but if you can at least start there from to 20 to 30% of profits, you’re not going to get hit with this giant bill that you will be completely not expecting.
[00:26:48] Scott: Yeah, it’s crazy to me that some people will just kind of guess and then at the end of the year they wonder why they owe $25,000 and they didn’t realize it or maybe they’re not even paying in all of the quarterly that they should be because they haven’t hired someone to do it. They’re doing it themselves, that’s just crazy. I can’t live like that. I got to know where I am almost every second of the day because I want to know that if I owe or if I’m in the positive, you know, it’s just the way that I am but yeah I think it’s smart to do that because you don’t want to wake up and say, “Oh my gosh, I didn’t realize that. I have to pay the government money that I haven’t sent in yet.” At least if you can have, like you said 20 to 30% somewhere in that range… Maybe we can just touch on that even though we talked about it before? Let’s touch on the different entities a little bit, LLC, S Corp, all that stuff.
[00:27:41] Josh: Yeah and this is by far one of the most frequent questions we get and also as your business starts to make money it’s going to be one of the most important questions that you can answer. There’s really four total entities that you’re looking at here, a sole proprietor or if you have multiple owners in your business a partnership. The next level up is the LLC, the Limited Liability Company. The next level up I would say is the S corporation and then finally you have the C Corporation. For 99.9% of you audience just go ahead and eliminate the C Corporation from consideration. It’s almost definitely not a good entity. Let’s look at those three options.
[00:28;17] Scott: Okay.
[00:28:18] Josh: The sole proprietor or the partnership is basically you’re not registering anything with the state, you’re not filling out any paperwork. You’re just hitting the ground running. You’re getting your product up on amazon, you’re selling and you and the business are one and the same. Maybe you file a DBA so it has its own name but you’re probably just operating as you. Maybe you registered for an EIN which is their business tax ID number but most likely you’re just operating from your sole security number and there is just no separation between you and the business. This is just fine if you’re just getting started, you don’t necessarily have any legal risk yet, you’re not making much in profits yet. This is totally fine. It’s going to save you time, it’s going to save you money.
[00:28:57] Scott: Okay.
[00:28:58] Josh: The next level up is the LLC. What’s interesting about the LLC is contrary to popular belief it has zero tax difference between a sole proprietor and the LLC. It’s actually not even a recognized entity by the IRS. All the LLC is it’s exactly what the name says, it’s a limited liability company which means it limits your liability personally if someone sues the company.
[00:29:23] Scott: Got you.
[00:9:24] Josh: I don’t even know what people that sell on Amazon might get sued for but…
[00:29:28] Scott: For they pinch their finger in the garlic press.
[00:29:30] Josh: There you go. Yeah, they pinched their finger straight off and they sued you. The idea behind the LLC is they’re not going to be able to come after your home and your car. They’re just going to be able to come after what’s in the business and that’s certainly something you’ll… If that is something of interest to you and you think you have legal concern, talk to an attorney because things get complicated when you’re the only owner because there’s still not much separation there because obviously you’re the one running everything.
[00:29:56] Scott: Yeah.
[00:29:57] Josh: The point is in this conversation there’s no tax benefits to it. It operates the exact same way. Let’s talk how they work first, the sole proprietor and the LLC. They’re what they call pass through entities, which means your business itself never pays any income taxes. Instead what happens is the profits from the business flow through to you personally and you pay the taxes. If your business makes $100,000, that $100,000 flows through to you, you claim it on your personal tax return and then you owe any applicable taxes based on that, on your personal return.
With both the sole proprietor and the LLC, not only are you going to get hit with all those ordinary taxes just like it’s any other sort of income but you’re also going to get hit with what they call self-employment taxes, which is an additional 15.3% tax. If you’ve never had a job and you remember them taking out those social security and Medicare taxes, that’s all the self-employment tax this is. You may not have known that what you were paying in, your company that you work for was also forced to match that. Now that you are both the business owner and the employee you’re paying both sides of that which comes out to that 15.3%.
Again, if you have $100,000 profit and when we say profit, we just mean after all your deductible expenses, what you have left is $100,000, you’re going to get hit with all the ordinary taxes and then that additional 15.3% tax which obviously is about $15,000 so it’s a big one. It’s a big deal and what’s really interesting I guess maybe is it doesn’t matter whether you took any of that out to pay yourself or left 100% of it in the company, you’re still paying taxes on all of it.
[00:31:31] Scott: Yeah, that’s big.
[00:31:34] Josh: As you can see you can get crushed pretty quickly. That’s where the S Corp comes into play. The S Corp works the exact same way as these companies for the most part. It’s a pass through entity. The business pays no taxes. Those profits flow through to you so that $100,000 dollars flows through to you, you pay the taxes on it. What’s different is you’re not getting hit with that 15.3% self-employment tax.
[00:31:55] Scott: Got you.
[00:31:56] Josh: As you can see that number can start add up pretty quickly. You get to $100,000, you’re talking about $15,000 tax on that alone. I’m sure some people thinking this sounds too good to be true. Potentially, part of it is, okay. The IRS isn’t going to let you get away with this completely.
[00:32:12] Scott: Exactly.
[00:32:13] Josh: What they’re going to say is, “Okay, fine, you don’t have to pay that 15.3% tax on all those profits but what you do have to do is pay yourself an actual salary now and on that salary you’re going to pay that same 15.3%. It’s just called payroll taxes.”
[00:32:26] Scott: Right, right.
[00:32:28] Josh: What they say is you have to pay yourself a reasonable salary. You can read 100 different sources and get 100 different answers on what reasonable salary is. Some of it comes down to common sense. If you’re making $100,000, $5,000 dollars salary is not reasonable.
[00:32:44] Scott: Exactly.
[00:32:45] Josh: What we normally say, somewhere around 30% and it could range anywhere from 25 to 40% of profits. The higher those profits are the lower that percentage can be. Someone that makes 50,000 dollars might pay 40% in salary where someone that makes half a million dollars might pay 25%.
[00:33:02] Scott: Got you, yeah, yeah.
[00:33:025] Josh: What your tax saving essentially will be on the difference between the profits and your salary, you’re going to save that 15.3%. Real quick example. Your business has $100,000 profit, you determine that a reasonable salary is $35,000 dollars. On that, $65,000 difference between those two, you save that 15.3%.
[00:33:27] Scott: Got you.
[00:33:30] Josh: Just one more though. The next big question becomes, “Okay but now I’m stuck. I only have $35,000. I need a lot more of that to pay myself.” The great part here is you can still take out as much as you want in what they call distributions and that has no impact on taxes because you already paid the taxes on those profits.
[00:33:47] Scott: Got you, yeah. That makes sense and the way that I understood it was and I’m pretty sure I’m correct but basically like you said, the business is paying you, as an employee, you’re then paying all of your taxes that you should be: your 15% tax, your social security tax, all of that stuff on that money. The business itself isn’t a person, it’s a business so you’re not paying the social security and Medicare and all that stuff on that money. If that money funnels to you after being brought into the business then that money is just being distributed to whomever.
[00:34:23] Josh: Yep, that’s essentially what it is.
[00:34:24] Scott: Okay.
[00:34:25] Josh: You have $65,000 left in the bank at the end of the year. You want to pay all that to yourself in the form of distribution, there’s no tax consequence for that.
[00:34:32] Scott: Okay. Now, there was one question I received. Actually it’s funny I was going on Steve Chou of MyWifeQuitHerJob. We had a little private session that we did with a bunch of his students, actually people that attended his event and they had this question because they listened to the podcast that you run and they had these questions I want you to answer it here. I tried to answer it there that night but I didn’t have the right answer but here is what they said. They said, for the question they asked you about the podcast, “You can backdate the S Corp election to the day the LLC was formed so if the LLC was formed 8:16, that’s when the S election would be good from, depending on when the business started,” that’s from you.
[00:35:15] Josh: That was my…
[00:35:16] Scott: That was your answer. Okay, here was the question.
[00:35:19] Josh: Let’s start with the question.
[00:35:20] Scott: Yeah, we got to start with the question. Okay, wait a minute here I got to go back now. Basically, the question was this… I don’t have the question in front of me I had your response. Basically you said that we can backdate it so if right now it’s August and we’re wanting to do this whole thing, you’re saying then we can backdate that to January 1st and then we can act as though we were an S Corp from then? How does that work?
[00:35:49] Josh: Yeah, so the first thing to know here is that an S Corp isn’t its own entity. What you’re going to do is you’re going to form an LLC and you’re going to make an LLC that’s taxed as an S Corporation because an S Corporation is simply a tax classification. What this means is if you’re an LLC on January first and you’re listening to this podcast on August the 16th and saying, “Holy crap I should have been an S Corp all year.” You can go back to January first of this year and be an S Corp for the entire year, right. The question becomes what if you’re not an LLC which they think kind of what he was going, could he form both an LLC and an S Corp and date it back to January first?
[00:36:30] Scott: Got you.
[00:36:31] Josh: The answer there is probably not. Well, first you definitely cannot backdate an LLC. If you form an LLC today, it’s going to be active as of today and then you can make an S Corp, make the tax an S Corp as of today.
[00:36:45] Scott: Right.
[00:36:46] Josh: Whether you can put the whole year’s income within that business or not, it depends on a lot of factors. Some of it depends on when it is in the year. Like if you’re doing it on January 15th, just put the whole business. You’re talking two weeks’ worth of the year.
[00:36:59] Scott: Right, right.
[00:37:00] Josh: August 16th could be a whole different story.
[00:37:01] Scott: It could be a little bit trickier although though right now let’s say that we were in August and we went ahead and did this so we’d have to do it a little bit differently because we already have six, seven months in the year already recorded?
[00:37:15] Josh: Potentially, worst case scenario you can only make it effective as of today and you essentially have two different businesses for the year prior to August 16th and post August 16th.
[00:37:26] Scott: Okay.
[00:37:27] Josh: However, let’s say that you did all your work through Amazon FBA. If you can do into Amazon and you can get them to treat you for their purposes like you were the LLC all year, then you’re going to be fine because they’re going to make that 1099 K or whatever 1099 they send out to the business at the end of the year, they’re not going to split it up.
[00:37:45] Scott: Okay.
[00:37:46] Josh: If you can get all the people that paid you money throughout the year to send those 1099s out and treat you as that LLC tax as an S Corp all year, you’re going to be fine. The problem is going to come if you have people that send some 1099s to you personally or to an old business, whatever.
[00:38:02] Scott: Right, so it’s really going to depend on how many people are going to be sending you those forms?
[00:38:06] Josh: Exactly and this is where every situation is different.
[00:38:09] Scott: Sure.
[00:38:10] Josh: This is where you want to talk to someone about your specific situation because there’s usually something that can be done, just some situations are trickier than others.
[00:38:16] Scott: Okay, okay and again that’s why you want to talk to someone like you versus just thinking that you know what you are doing.
[00:38:23] Josh: As opposed to just using Google.
[00:38:24] Scott: Or Google our friend. Everything must be true on Google.
[00:38:29] Josh: Right.
[00:38:32] Scott: Just to clear that up… Again, if you guys have any questions about this definitely just contact Josh. Email him and he can clear it up for you I’m sure because like he said everything is a little bit different and you can’t really say one way. Every situation is different. Okay, so what else you want to cover here before we wrap up? You want to talk about sales tax? Do we have to?
[00:38:58] Josh: Open a can of worms.
[00:38:59] Scott: Yeah, right, do we want to talk about that? We have to talk about that and actually I’m going to be having a guy on that’s going to be talking all about that. He’s from TaxJar so he should be coming on soon as well. We’ll try to get to the bottom of this. I’m not sure we’ll get to the bottom of this because I’m not sure anybody really knows the real answer.
[00:39:17] Josh: I’m not sure there is a bottom.
[00:39:18] Scott: Yeah, what’s your thoughts on it really quick? Maybe we can kind of dive in from there.
[00:39:24] Josh: Yeah so real quick what the rule states for sales tax is anywhere that you have nexus, any state that you have nexus in, you have to collect and pay sales tax on sales within that state.
[00:39:35] Scott: What’s nexus mean?
[00:39:36] Josh: Yep, so nexus is a fancy way of saying a physical presence in that state.
[00:39:40] Scott: Okay.
[00:39:42] Josh: For most people the obvious one is the state that you live and operate your business out of. You can’t get around this by saying I operate my business online so I do not operate in a state. Where your computer is located and where you’re butt’s sitting in that chair, that’s the state that you clearly have a nexus in so you’re in South Carolina now, right?
[00:39:59] Scott: Yep.
[00:40:00] Josh: You’re selling from South Carolina, you clearly have nexus and an obligation to pay sales nexus to South Carolina. What that means though is you only have to collect and pay that sales tax on sales within South Carolina. Someone makes an order from Texas and South Carolina is your only state of nexus, you do not have to collect sales tax on that sale to Texas. Here’s where things get tricky with Amazon FBA. One of the forms of nexus is having inventory stored within that state. Amazon has, last I heard, 14 different states?
[00:40:34] Scott: Yeah, I believe it’s 14.
[00:40:35] Josh: Yep, so 14 different states that they can store your inventory in. That gives you 14 different states plus potentially a 15th if your home state is not one of those 14 that you now have nexus in and according to the ‘by the book rules’, you are now required to collect and pay sales tax on sales within that state. Texas is one of those, California is one of those, Pennsylvania is one of those, Indiana. All these states, if you have a sale within Indiana and your inventory is stored there, you are expected to collect and pay sales tax there.
[00:41:07] Scott: Exactly.
[00:41:10] Josh: Now, if it’s sounding like a pain you’re right. It could be a pain. There’s no way around it. What I’d say first is probably 90% of people aren’t following this rule. They’re mostly collecting sales tax in the state they operate from plus maybe a few of the bigger states that they have a lot of sales in California, Texas, whatever but that doesn’t necessarily mean that you going that route means you’re safe. States don’t care what 90% of the people are doing, they care what they can collect money for. If you are one of the unfortunate ones that are ever caught not collecting sales tax where you need to, not only will you be responsible for paying that sales tax out of your pocket, you will also be hit with some pretty big penalties and interest.
What I’d say is one, this is an incredibly confusing topic. If you Google this like we just talked about our best friend Google, you’re going to find 10 different answers from 10 different CPAs and attorneys. Some people are going to tell you, “Don’t worry about it, it’s not true. The states can never go after you for this.” Some people will tell you it’s unconstitutional, some people will say, “You better do this or you’re going to bankrupt your business.” It comes down to a personal choice. I’m not going to tell you one way or another what you need to do here. You got to look at the options. I can tell you the letter of the law says that you need to collect and pay sales tax. Some people doubt whether the states can ever implement that and effectively go after people for not doing that. That’s up to you whether you want to buy into that or not. I honestly don’t know whether that’s true or false.
[00:42:42] Scott: You know what even gets a little bit more tricky and I’ve heard people saying, “Well, you know what I’m going to do, I’m just going to send all my inventory into one location for Amazon,” because you can elect to do that. You pay a little bit more to do that but you can do that so that way you can say, “All my inventory is in California. Now I know I only have to register in my state in California.” The problem with that is Amazon will take that inventory and it will disperse it amongst different warehouses because that’s where it’s closer to most of the customers that have been buying it over the past six months or whatever and then they’ll just start distributing your inventory all over the map and you don’t even know it. It doesn’t tell you.
Now, you are unaware of that and you really did it because you wanted to have to pay sales tax in that one state so you only had inventory there. That’s where it even gets even more confusing. Like you said, Amazon should be able to help out with this, you would think but they’re not. They’re like pushing it off on us as the seller which I think is wrong. If we’re at fault I think they should be at fault. Hey, I’m going to be right on record saying it because I don’t think it’s fair to do that. At least to then take all your inventory and move it all around without you knowing it or they getting your approval, yes, maybe the lead time will be longer for that customer to get it but again they don’t want that because people are prime they want to get it to you in a day or two and it’s always about their business model and I get it.
I know one solution if you’re not selling on Amazon, you’re selling on your ecommerce, you can just store into one location and then you can go by those rules about having all your inventory located in a facility center in California, whatever. It is a very, very tricky, very confusing thing here. I’m not really sure what the right or wrong thing is. What I will say is what you said and that is definitely your own home state and where you know that your inventory is, I think that’s a must. Technically, they want us to really register in all of the states. That’s pretty much kind of the gist.
[00:44:52] Josh: Yep and from what I’ve seen if you’re on Amazon long enough you’re eventually going to be in all 14 of those states right.
[00:44:57] Scott: Exactly, exactly and then that goes to the headache of okay well now you need someone to actually submit all of the different… Some of them are monthly. Some of the states are monthly, some of them are quarterly, some of them are yearly. Here’s the other thing too right. All of these states that want the tax, they make it very, very hard. You know this because you’re helping some clients do this right now. It’s hard to register in those states. A lot of it is by paper still. Anyone listening out there that can create something that all of the states have to come in together into one portal and then that’s how you file with like a few clicks of the button with your one time list and then everybody’s registered, that would be a way that they’d be able to make all of their money come through the door versus this is a lot more complicated, just makes it so much harder. Really, really does.
[00:45:48] Josh: If Hillary Clinton or Donald Trump are listening, please put this on your agenda.
[00:45:53] Scott: Yeah. I’m not sure. If the states want to have that revenue that they’re technically losing then I would put something in place. I would say, “How come we raise more dollars for this certain state? This is how.” Make it very easy.
[00:46:07] Josh: “Let’s make it easy for people to comply with the law you’re trying to make.”
[00:46:12] Scott: Yeah, exactly. That makes zero sense to me but hey, lot of that’s tuff does anyway but we won’t get into that conversation.
[00:46:22] Josh: I’m interested to hear your podcast with TaxJar because first of all they’re the people I recommend everybody to go to for their sales tax and second I want to hear what their stance on this stuff because it’s like I said, you’ll get a million different answers and these guys are the experts so I’m excited to hear that one.
[00:46:38] Scott: Yeah, I mean here’s the deal too though. We’re going to hear what their opinions are and what they think is the right thing to do but we also have to remember too we’re in a public forum here where we got to say what we think is right. Like me, I have to sit here and say the right thing to do is go register for all 14 states, start collecting your sales tax, paying it. I don’t know if that’s 100% the right thing. I don’t know if it’s necessary unless we know if our inventory has been moved. I don’t know what the right thing is.
[00:47:06] Josh: We know what the states think is the right thing-
[00:47:08] Scott: Yes, yes.
[00:47:10] Josh: We don’t know whether that can be enforced.
[00:47:12] Scott: Exactly, so for anyone to give like advice that’s saying like this is what you have to do, really what you have to do to be totally 100% covered is to be registered in all the states and file when you need to file and TaxJar will tell you what to file in but yeah, I’m curious to hear that as well because it’s a huge cloud that hangs over top of this business. Like you said, there’s probably 90%, maybe even more that aren’t complying and how are they going to go after everyone. If these states aren’t really… If they’re not up to par as far as figuring out how to get people to register successfully, how are they going to go after these people?
[00:47:51] Josh: Yeah. How’s California going to go after Scott in South Carolina when…?
[00:47:58] Scott: Exactly, although I am paying in California. That’s a big one for me. Anyway, any other thing do you want to touch on before we wrap up?
[00:48:09] Josh: No, I think we hit all the big points. We hit the business expenses, the inventory, we hit the business entity, bookkeeping, sales tax. Anything else that you can think of that we’re missing here?
[00:48:19] Scott: No, I think we’re good. I want to recap like on our last episode but I wanted to have you back on because I know that you receive a lot of requests and questions and I thought it’d be good and I think it was good to be able to go over these again and then also address some other new concerns. Inventory’s a big one. That’s a big, big one, if you guys are thinking to yourself, “I just spent $10,000 and I’m going to write that off and now that’s a huge write off, might not be. Definitely don’t fall into that trap, that’s a big nugget right there for you.
[00:48:50] Josh: Absolutely.
[00:48:51] Scott: Yeah, so we’ll probably have you back on too, maybe even before the first of the year, give us some last minute tax tips that we can go ahead and maybe get those in before the clock strikes 12. Hey, Josh I want to thank you once again, always a pleasure. You’re always very, very helpful and I know a lot of my listeners have contacted me and said that they’ve been really, really happy with either using your service or just reaching out to you and getting an answer because you’re generous enough to do that so I want to thank you once again and I appreciate everything you do.
[00:49:20] Josh: Yeah, your audience is awesome and I think I told you but because of being on the podcast last time, I actually had a national TV appearance on the Hallmark channel because someone there had heard me on this podcast so shows to the reach that you have and how much success you’ve created with the podcast.
[00:49:34] Scott: That’s awesome, I remember you telling me about that. We never even caught up on that so did that 100% happen?
[00:49:39] Josh: It did, yeah, I’ll have to send a link of the video and you can maybe put it up with the page or something people can…
[00:49:44] Scott: Yeah, that will be really cool. Awesome man, that’s awesome, congrats on that too.
[00:49:49] Josh: Thank you.
[00:49:50] Scott: Yeah, all right man. We’ll talk to you soon and just keep us posted. If you hear anything that happens in the meantime I know you’ll always be keeping us up to date but now that you’re really in the trenches in the Amazon ecommerce space, so yeah, if you hear anything let us know and thanks again. I appreciate it.
[00:50:06] Josh: Sounds good, thank you.
[00:50:07] Scott: All right man.
Okay, so there you have it, another great episode, another great conversation with Josh Bauerle from CPA On Fire. If you guys want to learn more about Josh or maybe you want to hire him or maybe you just want to go through his free resources, head over to cpaonfire.com, again that’s cpaonfire.com and yeah, he’s a great guy. He knows a lot about taxes but he knows a lot about this ecommerce/Amazon space now that he’s been really, really focusing on that because he’s had a ton of requests for it so obviously he needs to learn more about that as well and he has done that and he’s sharing here and he’s just a great resource.
Definitely go check out his webpage there at cpaonfire.com and feel free to reach out to him and ask any questions that you have. Just want to again just say thanks to him for coming on the show, it was awesome and I always love being able to really pick his brain but then also listen to what other people are asking because those are very, very common questions that we probably all have had and maybe just one little small tweak in thinking and when we’re doing our books is going to allow us to be able to prepare better so we’re not, pardon the pun here, but caught with our pants down.
I’m not sure if anybody says that anymore but when I was growing up that’s all I ever heard was my father saying, “Hey, you don’t want to get caught with your pants down.” Anyway, that’s probably showing my age, I apologize for that. Anyone else that’s around my age, you guys know what I’m talking about. All right, that is going to wrap it up. Definitely go check out the show notes too as well, we’ll have everything linked up there. Possibly that video that he mentioned will be there as well. He got a pretty good little TV spot because he was on the podcast and they wanted him on for some tax advice so that will be pretty cool to see as well. Definitely go check that out and again that will be on the show notes.
[00:52:08] Scott: This episode is episode 251 so head over to theamazingseller.com/251. You’ll have the show notes, all the transcripts, all of the links we talked about, discussed will be there. His last episode that he was on 143, that will be there as well where we really talk a lot about business entities and some additional tax tips. That’s pretty much going to wrap it up. Remember guys I’m here for you, I believe in you and I’m rooting for you but you have to, you have to… Come on say it with me, say it loud, say it proud, “Take action.” Have an awesome, amazing day and I’ll see you right back here on the next episode.
LINKS MENTIONED IN THIS EPISODE
- www.TheAmazingSeller.com/143 – Previous episode with Josh
- www.CPAonFire.com – Josh’s business website
- Xero accounting software
- Bench Bookkeeping Service
Josh was featured on the Home & Family network after being on the TAS podcast. One of our listeners is a producer of the show and wanted Tax advice.
Pretty COOL 🙂
Check out the segment here.
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