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There are a ton of people out there sharing a myth that is actually a misunderstanding and can get a lot of people audited and in some deep, deep waters with the IRS.
The myth is that you don’t have to report your income until you meet a certain threshold.
I’ve seen this threshold at $400, $600, even $20k! The thing with myths is that there are always *some* truth to them. I’ll share that truth and you can share this instead of the myth!
I hate to be the bringer of no fun, but you actually have to report your income from the first dollar (technically first penny, but the IRS typically uses rounded numbers on their filing forms).
We are all relatively familiar with federal income tax, the one we have to file every year before April and anxiously wait for a tax refund. With a business, not much changes. As a Sole Proprietorship or a single member LLC, we will simply add a form or two to our personal taxes that we usually file. These forms are called the Schedule C and the Schedule SE.
(If you use a box program, you may not realize it, but all of the questions they ask you are related to figuring out what forms, or ‘schedules’, should be added to your personal 1040.)
The Schedule C’s job is to determine if your business had a profit or a loss. On it, you will indicate the business’ gross income (every penny that came into your business), any and all allowed expenses, and your inventory. There is also space for Business Use Of the Home (BUOH) and vehicles.
*Note: Inventory is not an expense until it is sold and off of your shelf, this is a discussion for another post.
Here is where the $400 myth begins.
If the calculation on the Schedule C shows a profit of $400, then you’ll be instructed to fill out the Schedule SE for Self Employment taxes. You have to fill out the Schedule C to know if you have a profit. Without the Schedule C, you have pure profit and will potentially owe taxes on that full profit.
Filling out the Schedule SE does not automatically mean you’ll owe taxes though. See, again, this form is another calculation. You’ll enter in your numbers from the Schedule C as it instructs, do a little dance, stick out your tongue, and, ta-dah!, you have yet another number to consider. If it is below a certain amount, you won’t owe for that. If it is above a certain amount, then you may owe on it.
Keep this in mind as we continue. All income, no matter what form or schedule it is put on, is added to your personal 1040 in a specific place so that it can be accounted for in your total “story” of your financial year. From that, the 1040 figures out what your tax liability *actually* is, that is, whether or not you’ll owe. So even if the Schedule SE says you owe, you may not actually owe.
Ok, let’s continue. Where do the $600 and $20k myths come from?
These come from the 1099 forms. We talked about this in our last post [here], but I wanted it here too because it’s part of this reporting myth.
A 1099 form (and there are lots of them) is only a matching tool to make sure you are actually reporting what you were supposed to. If you receive a 1099 from PayPal and from someone who paid you using PayPal, not to worry, you match them up and put them in your records. The IRS will know they match up by your ‘story’ that you tell them and by the codes on the 1099 (K, NEC, MISC, etc.).
Payment processors (used to) file 1099 forms at 200 transactions AND $20k while contractors would be sent a 1099 at $600. That is where these numbers are coming from. To note that as of 2022, payment processors will now file those 1099 forms at $600 as well, but nothing changes on your end, you will still report your gross income, take all allowed expenses, and fill in the story about your financial year.
Finally, I want to reiterate that as annoying as they are, filing all these forms/schedules with your 1040 is helping you create your financial story to the IRS so they know how much you actually owe, or how much they owe you.
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