All Xero Gravity episodes
Hosted by Elizabeth Ü and Gene Marks
14.6 million self-employed Americans pay a 15.3% self-employment tax (made up of SSI and Medicare), federal, state and local. It sounds like a lot of headaches, but it doesn’t have to.
Together these two gentleman, along with Elizabeth and Gene, break down tax misconceptions and mistakes, and share real solutions that’ll help you get yours right.
So when you tune in to Xero Gravity #39, have these in mind: Know how a Schedule C works? Tracking business expenses? Organized your receipts? Understand quarterly taxes?
Plus, you’ll hear about Elizabeth’s dance moves, how Gene almost made her tear her hair out (unrelated), avoiding the IRS, and the sweet new Xero Tax Touch app!
Small Business Resources:
Hosts: Gene Marks [GM] & Elizabeth Ü [EÜ]
Guests: David Emmerman [DE] and Rafael Alvarez [RA]
You’ve just tuned into Xero Gravity: a podcast for small business leaders and entrepreneurs across America. Now to your hosts, Gene Marks and Elizabeth Ü.
GM: Welcome back to Xero Gravity. Hey Elizabeth, I’m wondering if you could take us back to when you were self-employed. What was the top tax headache that you had at that time? How did it make you feel?
EÜ: Oh that’s easy, the biggest nightmare that I had was that I never kept track of my mileage. So when I was self-employed I was doing a lot of speaking gigs and so I’d travel all over the place, and I was terrible at keeping track of my mileage. So I literally would be there like in April when I’m trying to fill out my tax return with Google Maps open, and I would literally go through the entire calendar’s worth of speaking engagements and try to figure out how many miles it had been for each of those trips. It was a total nightmare and I was so mad at myself for having waited so long to address this. It just took so long and it was so frustrating. I mean it’s making me tear my hair out just even remembering it, so thanks for that memory Gene.
GM: Well tsk, tsk, tsk on you. You know, I tell you, Elizabeth, when people ask me what tax mistakes I’ve made, of course I’ve made no tax mistakes ever in my career. I am a CPA, and CPA’s do not make tax mistakes. So Elizabeth, you understand.
EÜ: I bet you made no mistakes ever at all, right Gene?
GM: None at all on this topic. Deductions all the time, my books are completely clean. In all honesty, I’m also at fault for not just keeping good records and not keeping track of my receipts. I know a lot of clients do that as well because you’re running around and a big tax mistake is not maximizing your deductions that you could be taking. And freelancers, they make that mistake all the time because, you know, they’re so busy doing their work that they don’t think about their own best interests — which is good record keeping.
EÜ: Well today’s episode is the perfect panacea for all you freelancers and contractors who are suffering from these awful tax-related headaches.
Xero Gravity Promo
GM: We’re part of the Xero Podcast Network and we’d love you to subscribe
to the show in iTunes.
EÜ: And leave us a review: the link is in today’s show notes on
GM: Let me tell you about our guests Elizabeth. I don’t know if you remember David Emmerman. He’s a Partner at Emmerman Boyle & Associates and Rafael Alvarez, who’s the CEO at Atax.
EÜ: Our two guests will walk you through some common misconceptions, and some great solutions for you to implement right now, to make sure that tax time is much easier for you next year.
One great tool that you might want to keep in mind that we’ve actually just launched here at Xero, is called Xero Tax Touch. This is a way for you to organize your business expenses, simplify your taxes, and grow your business right from your phone. It’s really fun — I’ve been playing with it. It’s almost like Tinder, you know. You swipe your business expenses to the right or to the left depending on whether they’re business or personal expenses. You can really easily enter those mileage calculations so you won’t end up like me at the end of the year, trying to go back through your whole calendar.
It also makes it really, really easy for you to estimate just how much tax you owe, so that you put aside enough and don’t find yourself in trouble at income tax time without enough money saved from everything you’ve earned as an independent contractor or freelancer. Again, that’s called Xero Tax Touch, and do check that out.
EÜ: Welcome back to Xero Gravity. Today we have on the line Rafael Alvarez and David Emmerman. And I want to tell a little bit of a story about how Rafael and I first met. It was on a dance floor. We were the first ones on the dance floor at a conference that some of you listening may have actually attended.
RA: Getting the party started! That was very fun. I mean I remember dancing with you Elizabeth. That was fun!
GM: Rafael, everybody wants to know: What kind of a dancer is Elizabeth? Right, I mean a tango? How is she on the dance floor?
EÜ: The wet noodle!
RA: She was kind of dancing, she’s getting into the mood, moving around. We had a live band performing and the music was great, and she was really into the music.
GM: Rafael and David, thank you both for joining us today. We wanted to learn a little bit about you guys and why you’re here. We’re going to be talking about freelancing and tax headaches, and all that. So Rafael, let me start with you: Tell us a little bit about yourself.
RA: Well I’m the President, CEO and founder of Atax franchise. It’s a franchise in the tax preparation, bookkeeping and payroll industry. I started the business back in 1986 with $200, two computers and a fax machine. By 2005 the business went viral, completely out of control. I decided to launch the franchise and since then we have opened up over 40 locations across the nation, and we keep growing.
GM: Fantastic! What about you David?
DE: So I got into the business around 2001. I’ve been preparing returns for, I guess, coming up on 15 years or so now. I’ve been an enrolled agent since about 2006. My partner and I actually purchased our practice from my father back in 2004, so I’ve been around the business since I was born. His practice started around 1969. So believe it or not we still have clients from all the way back then.
EÜ: Wow! So our topic today is tax headaches and solutions for freelancers. I recently read a report from the Pew Research Center that said that in 2014 some 10% of American workers, that’s over 14.6 million people in all, were self-employed. So Dave, maybe you can help me understand this: whether you’re self-employed or a freelancer or a contractor, these are all the same, right? Or how does the IRS define someone who’s self-employed?
DE: So the IRS defines somebody that’s self-employed pretty basically, by saying that they are not working for somebody else. Or, in their working for somebody else, they’re working as a subcontractor. They’re not a W2’d employee, meaning that they don’t have any taxes withheld — they’re receiving the full amount of the income.
GM: So what makes them different, David, from a tax standpoint?
DE: They have different tax ramifications because there’s no social security or Medicare being withheld from them. There’s no federal and/or applicable state or local taxes being withheld from them. So they’re responsible for the full amount of the tax on the income that they’re generating. They have the ability to take deductions and reduce some of that gross income down to what would be the net profit, after their applicable business deductions. But then at that point they’re subject to regular income tax, state income tax if applicable, and the self-employment tax — which is usually the biggest surprise.
GM: Right, and Rafael do many of your clients, do you find many of them are freelancers and self-employed people, and has that grown a lot?
RA: We have a lot of self-employed clients that way. Our main location, our flagship store, we prepare about 10,000 personal tax returns. There is a mix, because there are self-employed people that that’s all they do, they are 100 percent self-employed like the taxi drivers — people that are just doing sales, etc. And there are people that have a combination of W2s and also self-employed or 1099. Like I have a lot of clients that are in retail,. They’re working in a clothing store or selling in stores like Macy’s, Bloomingdales, Saks Fifth Avenue, and some of them get a combination of both. Some of them get a 1099 of which no taxes are being deducted and they also get a regular W2.
I have self-employed clients that are owners with legitimate business like they own pizzeria, and instead of having a corporation they just have regular self-employment. They’re running the business as self-employed even though they have a real store with staff. The other ones are independent freelancers that just perform a job, and they get paid without taxes being taken out.
EÜ: And so I imagine that if you’re a freelancer, or you’re this creative independent contractor, or you’re an Uber driver, or you’re a pizzeria owner, you’re really passionate about the business that you are running— but maybe not so passionate about filing your taxes. So what are some of the things that are problematic for freelancers when it comes to filing their taxes?
RA: Well the biggest headache is, I would say the receipts. Most of the freelancers, they have no organization whatsoever, they usually like to come in to get the taxes done with bags loaded with receipts, and I hate it because you know…
EÜ: Oh no, that really happens?
RA: all the time. I mean here I am, I came to get my taxes done, but all they have is two or three bags or envelopes completely loaded with a lot of receipts. They don’t have a system that will keep track of their income and their expenses, and we have to go crazy. Some do Excel; they use Excel to organize their books.
They just go there day to day, and they perform the job and they make the money, then at the end of the year when it’s time to file the taxes, they just have receipts. They have nothing that can really demonstrate their income and expenses. Like the Uber driver now, they are kind of changing that particular industry, because most of their income has come in on credit card transactions. Now their income is somehow recorded, so the government and everybody knows exactly how much income they generated and then the rest is just the receipt. Traditionally they have no organization at all.
GM: David, tell me, if you are a freelancer, what type of record-keeping practices should you be making sure that you do?
DE: I would say that best practices for freelancers is really to make sure that they’re organizing their expenses throughout the year. To get to the end of the year, as Rafael just mentioned, and have this big bag of receipts and come into the office and have the expectation to get an accurate tax return done is not a real expectation that can get met by most tax preparers. It’s very difficult to be able to sit there and go back over the last 12 months, and actually track back to what was a legitimate business expense, versus just a personal expense.
And if all these funds get comingled into one personal bank account, then you’re creating a much more difficult situation for both the client and for the accountant. So best practice is make sure that you stay on top of where those income and expenses are throughout the year, so that you’re able to actually deliver better information and a more accurate tax return.
EÜ: If you don’t do that, you haven’t been keeping track throughout the year. What are some of the surprises? Dave, can you mention some of the things that might happen if you aren’t keep track very carefully?
DE: The first thing is you might overestimate what your expenses are, right? And that’s problematic because you’re not necessarily entitled to all expenses that you might think that you spend towards your business. As an example, you might think that every time you go to the gas station and you spend money on gas for your work vehicle, that those are fully deductible expenses. But that’s not always the case. On the flipside of that, if you’re not keeping good track of your expenses, you might actually be leaving quite a bit of money on the table. So tracking everything as it goes through the account — and you’re spending the money throughout the year — proactively allows you to make sure that you’re not either leaving money on the table, or taking too much money off the table, which would be much more problematic.
RA: I was going to jump in and also add that there are other ramifications, and the big one is coming from the Internal Revenue Service, because on many occasions the IRS cannot verify their income. Now, when you work as a W2 employee they can see your income on the tax that you pay. As a self-employed person, they have no idea what your income is. Maybe the income that you’re reporting is accurate, maybe it’s not. So on many occasions, the Internal Revenue Service send a letter to these self-employed taxpayers asking them to prove their income and their deductions. And if they cannot prove that the business is real, number one, they might not be able to get the credits or qualify, or get the refund.
EÜ: And so are all these freelancers and self-employed folks that are receiving, instead of W2s from their employer, they’re getting a 1099? And what kind of tax forms are they filling out?
DE: So they’re typically filling out a Schedule C. The Schedule C is the form that gets attached to your 1040, that reflects income and expenses from self-employed earnings.
EÜ: And what kind of things do you have to put into that Schedule C?
DE: All your gross receipts and your inventory, or cost of goods sold, that you might have. Any sort of expenses related to the business whatsoever.
EÜ: So I know that there are some problematic categories and you already mentioned meals and entertainment, but I used to really sweat over vehicle expenses. For instance, I’d never keep track of where I was going or why, and then I was really in a fix at the end of the year when it came time to file my Schedule C. Can you describe the different ways of keeping track of vehicle expenses, and why that’s important?
RA: There are two ways: You can either declare the actual expenses or the actual mileage rate. You can keep track of the mileage related to business. The problem that I see all the time is that there are a lot of taxpayers that want to claim vehicle expenses that are mostly related to commuting, for instance. People want to claim, oh, you know, every time I work, I go from home. Usually mileage or commuting expenses from home to work or work to home are not deductible — it has to be related to your job. And if you claim the mileage the government or the IRS will expect you to have a log of all the different places that you visited. So if you claim 10,000 miles a year, they expect you to have a log that will indicate on a particular day you went from point A to point B. You add up all of those miles, then at the end you will be allowed to claim the deduction. But what you have to see is whichever is higher, either the expenses or actual mileage, because the government rate is like 50 cents per mile.
DE: Yeah, I think for 2015 it is 57 and half cents.
RA: You either claim the mileage rate or the actual expenses, whichever is higher. But it has to be related to your job. It cannot just be a personal deduction.
GM: David, we were talking about different expenses to make sure we’re keeping our taxes in line. But one of the other big issues that I always encounter with different clients of mine, is putting money away for estimated taxes. Do you encounter that with your clients and what do you recommend?
DE: The freelance market and the subcontracting market tend to be an area that does not necessarily withhold enough money throughout the year to be prepared for their tax liability at the end of the year, or even quarterly. So it’s very difficult for folks sometimes to be able to manage their cash flow throughout the year, and make sure that they’re making adequate estimated tax payments throughout the year, so they’re not burdened with a large tax bill or a sum they have to pay at the end of the year. As long as you can start tracking your income and expenses, and you have an idea as to where your net income is going to land, it actually makes it a lot easier for you to manage your own cash flow and set aside a certain percentage of your revenue every single month, or however often you get paid, to make sure that you have those funds ready.
GM: Rafael, do you have any sort of guidelines that you tell your clients to follow about putting money away for their tax? Isn’t there a rule about you want to make sure at least you’re paying in 100% of last year, or 90% of last year, and 100% of this year? I forget what the rule is.
RA: Well technically our tax preparation software will get the job done. At the end of the tax preparation, if you end up owing or you have a balance due, it will automatically calculate your estimated tax payments. We print out all the vouchers, usually four vouchers that we provide to the client, and they already know more or less what to pay. As long as their income is going to be similar, because every year is different. If they know that they’re going to be expecting the higher income, then they have to add more to whatever we calculated. Usually our tax preparation software performs the calculations. There are four payments, one due on April 15, the second one June 15, the third one September 15, and the last one in January 15 of next year. I have clients that they’re even contributing more than the voucher will indicate because it’s just a matter of at least having enough to cover the tax liability at the end of the year.
EÜ: So Dave, I know that there’s also some benefits to keeping your expenses organized, that have to do with the value that you can get from a visit with your tax adviser. So maybe you can explain what a tax preparer can do for you if you become organized, versus what you might be missing out on if you come with that huge bag full of receipts?
DA Sure. So if you could imagine the experience of showing up with the big bag of receipts, the focus for your accountant at that point is really to dive through the big back of receipts and try and get, you know, get some organization, get some of a grasp on what you actually have going on there for the tax return. But what that takes away from the experience of meeting with your accountant is being able to proactively look at what does the upcoming year look like? What other deductions should we be talking about, what other items should we be really planning for, for this upcoming year? And what kind of issues do you have going on?
As Rafael just mentioned, the estimated taxes are fine if they’re consistent throughout the year. But if there’s an additional amount of revenue coming in for the upcoming year, you really want to be able to have that conversation with your accountant at the time that you’re doing your tax return or throughout the year, to be able to actually proactively be able to make the additional payments to your estimates, if necessary. So when the accountants aren’t burdened by organizing that massive bag of receipts that people walk in with, they have the opportunity to talk more proactively about what’s coming up, and what’s changing in your life, and how does that impact your tax return.
GM: Rafael, you know, we talked about Schedule C filings for freelancers. Is there a time when you actually outgrow filing a Schedule C?
RA: The way I see it: the IRS would love to go after self-employed clients, they love to audit them because they realize that the majority of them are totally disorganized, so it’s a no brainer. They know that they have nothing to lose every time they ask a self-employed person: prove to me all your deductions. So for me, when I see a client that is already generating over $100,000, I strongly recommend they incorporate; create a corporation. There are a lot of benefits when you incorporate your business, like having less liability in terms of a lawsuit, instead of you personally being responsible for anything that happened in the business, now you have some protection by having a corporation.
A lot of people like the LLCs. LLCs are great. But I’m going to be honest with you: I hate it when there is a single member on an LLC, because now you’re being forced to report all of those income and expenses on a Schedule C. I don’t know if you know this, but within the last three or four years the whole self-employed industry in the United States went completely out of control because there is a segment, there is an industry called network marketing. And within the network marketing industry, they promote people to join those businesses. You will be self-employed, you will be able to report your income and expenses, but most of them, they report losses in the business.
RA: And when you report a loss, if you have another job, then that loss is reducing your taxable income. And by reducing taxable income you are getting a bigger refund. So what the Internal Revenue Service did, they created a small business department that is targeting anybody that is self-employed and is reporting a loss. It has, I would say, there’s at least an 80% or higher chance that you’re going to be selected for an audit.
EÜ: People always want to overestimate their expenses and under report their income when they’re self-employed, right?
RA: That is correct. So it’s a big issue, and I’m very hesitant to even report losses. And sometimes, and I’m sure David will relate too, when they come in with all their receipts, we do everything by the book. We report all their expenses, but two years later, when they get selected for the audit, now the receipts are gone. They moved, they don’t have them, there was a flood in their house, whatever, and there is nothing to back up the expenses. And they end up owing a lot of money to the federal government and the local state government.
EÜ: Right, so that further instills the importance of keeping track of your expenses as you go along, making sure you know exactly what you owe, and exactly what your income is, so that you can both estimate the taxes you might owe, and make sure that you’re in a safe spot as far as not necessarily having too high a risk for audit.
GM: So look, you guys have been practicing this for a while, and Rafael, David, you’ve seen a lot of clients that have come and gone, going back in time when you were first starting out in your practice. So I’ll direct this to you David: is there anything you’ve learned from dealing with clients and particularly freelancers, that you wish you knew when you were a lot younger? Any certain mistakes that they made, things you wish you could have advised them from the very beginning, that you’ve learned over the years?
DA I don’t know what you’re talking about — I am a lot younger! I would say that it’s really just more about proactive expectations, so that the clients can understand where the tax is coming from. A lot of times freelancers will get paid more than working as an employee, but that’s also because that they have more tax that they have to deal with, right? So the self-employment tax is 15.3%, which is both the employer and employee’s portion of social security and Medicare, that as a self-employed individual they’re fully burdened with. So that’s something that from day one I would love to have been able to really educate our clients on — being able to be as proactive as possible with our clients, which would certainly help to reduce the surprise and impact during the tax return visit.
EÜ: And Rafael, what about for you: What do you wish you knew or what do you wish that you’d been able to tell your clients earlier?
RA: I’ve been in the industry for, it’s going to be 30 years this year, and I learned by making a lot of mistakes and what was going on, what’s happening now, is that the IRS has turned the tables.
Look, it’s simple. Instead of going after 150 million taxpayers, the IRS realized that it’s easier to go after the accountants, making sure the accountants are the ones really doing all the due diligence, making sure that each business is properly registered. What I’m doing now is — those clients that are self-employed and they don’t have a business registered— we created a department within my company that helps the client to get a business certificate, get a federal tax ID. And now we’re even doing the whole process of incorporating the business, to help them have the business complete, legitimate, and having all the different licenses required by the local government. So like that, there are less issues, less penalties. That’s how we do it now. I wish I would have done it like this, many, many, many years ago, I would have saved a lot of headaches.
EÜ: Well thanks so much for joining us. We’ve had Rafael Alvarez and David Emmerman on the line. We’ve learned so much from what you’ve had to offer, both for those people who are freelancers and independent contractors who are working for themselves and may be struggling to fill out their Schedule Cs, whether or not they have kept track of their expenses throughout the year. And also for the tax preparers that are helping them fill out those forms as part of their tax returns. So thanks again for joining us.
GM: Thank you.
DE: You’re welcome.
RA: My pleasure.
Xero Gravity Break
EÜ: Well that was super helpful in terms of outlining some of the challenges that freelancers and self-employed people have when filling out their Schedule C forms, as part of their personal tax returns.
GM: I agree Elizabeth. You know, David and Rafael made some great recommendations. If you’re a freelancer there’s so much that you have to know to keep track of, like your expenses and how to really maximize the tax deductions that are out there. Some of the things that really resonated with me: not only keeping good records, but also keeping track of your payments. Because if you’re not making your payments on time and if you fall behind, it could really kill you when it comes time to making those tax payments. You’ll owe interest, you can owe penalties as well, and a lot of freelancers really get in trouble by falling behind.
EÜ: And again, I really think that Xero Tax Touch is going to be a great solution for freelancers and contractors, that they can try out this year. So visit Xero.com/us/taxtouch to learn more about it, and how you can get it on your iPhone. Well that’s all for today folks. Make sure you clear 30 minutes in your calendar for next Wednesday, because we’re going to be chatting with a real-life Wizard!
GM: Ahhh a Wizard? Harry Potter?
No it’s the wonderful Rand Fishkin, the Wizard of Moz. Rand is founder and former CEO of the marketing software company Moz, and co-author of a pair of books on SEO. I think he has another book coming out soon, and he’s co-founder of Inbound.org. And we’ll have more of Rand’s incredible story next week on the show.