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How a home-based business affects
a couple's taxes
Dear Small Biz Adviser:
Now that our youngest child is 10 years old, my wife has decided
that things should be quiet enough for her to give private piano
lessons. From what I can figure, she will average 50 lessons a month
at $15 a lesson, or about $750 a month before taxes, Social Security,
etc. I will make $80,000 this year, and we have always filed jointly.
We purchased a new piano for $8,000, and she will
be giving all lessons at our home. Does that have any notable bearing
on what we could or should do? How should she set up her business?
What forms do we need to submit? What organizations do we contact?
I'm trying to generate a checklist of what we need to do to take
care of this stuff. So far I have:
A. Along with our normal
1040 stuff, fill out a Schedule C for this tax year. Can we depreciate
the piano on that form? Can she deduct payments or pro-rate the
cost of the piano?
B. Do we need to fill
out a 1040-ES now for estimated taxes? Since we file jointly,
and she has always been a "dependent" on our joint return,
does this affect how the 1040-ES is filled out?
C. She will have to
pay Social Security, correct? Will the 1040-ES cover that?
D. If our joint return
has always ended up in us getting a $1,000-to-$2,000 refund for
the last several years, and nothing else is changing significantly,
will the 1040-ES also take that into account?
E. Since her income
will be in addition to mine and we probably will itemize our income
no lower than the $45,000-to-$109,000 range, her income will also
be at the 28 percent rate, correct?
Mainly I just do not understand how to set her up
to pay her taxes and Social Security, and then how this will be
input into our joint return. We still can file a joint return, right?
Thanks for your time.
Jack
Dear Jack:
Before going through the ABCs you outlined above, let us consider
some preliminary steps.
1. If your wife is
going to promote her business and use a company name other than
just her full name, you will need to file a fictitious name form
with your state. Go to Global
Computing's state directory to locate your state's Web site
and corresponding location to secure the fictitious name form
and fee information.
2. It is possible your
wife will need to secure an occupational license from the city
and county (or parish) in which you reside.
3. Since the lessons
will be provided in your home, be certain to investigate any limitations
and requirements associated with home-based businesses. Some communities
are very regulatory of such ventures, while others have limited
requirements associated with parking, signage, noise and traffic-flow
issues.
4. I assume your wife
will not employ anybody to assist the operation of her business.
Therefore, her Social Security number will also function as her
Federal Employer Identification Number.
Now let's address your new-business ABCs.
A. You're correct that
Schedule
C is the form your wife will use when filing Internal Revenue
Service returns for the proprietorship. You also should review
the IRS
Tax Guide for Small Business to get a better understanding
of what the IRS seeks in returns and bookkeeping. While reviewing
the publication, tour the sample returns. Though directed to corporate
structures, most of the procedures and forms remain the same for
a proprietorship.
As for depreciation, use Form
4562 to depreciate the $8,000 piano. The 12-page
instruction booklet should clarify any questions you may have
about this form.
You'll submit the Form 4562 and Schedule C with your
individual tax return (along with any other documents, such as Schedule
A for itemized deductions). Your tax return instructions will detail
how to apply the Schedule C information to the Form 1040.
B. Regarding Form
1040-ES, since taxes will not be withheld from your wife's
piano instruction fees, you are correct that she will need to
file this form when she begins earning income from the piano lessons.
Generally, these are quarterly payments, but if you do not begin
earning untaxed money until the fourth quarter, then you will
make only one payment, not four, that tax year. When the first
payment and voucher are submitted to the IRS, the agency will
send more forms.
The 1040-ES worksheet allows you to compute your estimated
tax bill based on your filing status -- married filing jointly,
single, etc. That means if your wife files a Schedule C and as a
couple you continue to file a joint 1040 return (which I suspect
will be more favorable for you), you should consider your household's
total income and taxes paid by other means, e.g., your withholding,
for figuring your total estimated tax due.
C. You also are correct
that your wife's self-employment will require payment of self-employment
taxes for Social Security and Medicare. These taxes are figured
into your estimated tax payment on the Form 1040-ES worksheet.
It may be her income is greater than expected, and she may want
to send more self-employment tax payments so she doesn't owe more
when filing returns. However, I suspect that first-year performance
will be such that her taxes will be minimal. Final determination
of what she owes for the year will be the net income from Schedule
C. She may over pay or under pay. However, there is no concern.
If she possibly owes more such taxes when all taxes for the household
are aggregated on Schedule 1040 , it is simply deleted from any
return due to your household for the year.
D. As for you typical
annual return, keep in mind the self-employment taxes your wife
pays may or may not impact your refund. As I noted above, if she
does not pay sufficient self-employment taxes during the year,
the difference will be deducted from the refund amount.
E. Finally, the net
income supplied in Schedule C is inserted in line 12 of Form 1040.
So there is no differentiation of tax rates between your income
and your wife's income. Based on the information provided, you
assume correctly that the adjusted gross income will fall within
the range you indicated.
I hope this clears up any concerns you may have, and
congratulations for planning these tax matters in advance.
-- Posted: Nov. 15, 2001
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