April Showers - Taxes Rain On Networkers

By Jeffrey A. Babener
  January, 1997

April 15 - Remember!

April 15 - Does this ring a bell? As Yogi Berra said, "Deja vu all over again." All is not lost. Come April 15, you may be glad that you started your own network marketing business.

For those who take their network marketing business seriously, there are serious tax advantages to be involved in this home-based business. With this silver lining, however, this cloud comes with volumes and volumes of IRS codes, regulations and interpretations that could regularly employ a small army of tax lawyers and accountants. It is better, however, to have a taste of this subject area and ability to spot of some of the issues, and so here is a sampler of some significant tax points for network marketers to take up with their personal CPA or tax advisor.
  1. No Hobby Losses Please!
  2. Meals and Entertainment
  3. Home Office Deduction
  4. Ordinary Business Expenses
  5. Traveling Networker
  6. Business Gifts
  7. All Those Forms
  8. Computers, Automobiles and Capital Assets
  9. Recordkeeping - The Name of the Game

1. No Hobby Losses Please!

Remember, if you are going to take advantage of the tax treatment of your network marketing business, it has to be a real business. The IRS says that, if you are going to deduct your business expenses from your network marketing business, you must engage in this business as a "for profit" business and not as a "hobby business." The IRS will look at either of two tests to determine if you are a serious business. The first objective test is that you make a profit in three out of five years. In a second subjective test, you must be prepared to demonstrate that you engage in your business in order to make a profit. Here the IRS is looking at whether or not your carry on the business in a businesslike manner; the time and effort you put into the activity; whether you depend on income from it; your expertise in the business; how much profit the activity makes in the years it does profit; etc.

2. Meals and Entertainment.

Network marketing is a social business. You have to eat and you may as well have some fun and do it while you are recruiting or selling. This is one of those expenses the IRS keeps whittling away at, however. Your deductions are now limited to 50 percent and you will need to be able to document the substance of the business discussion, the business relationship and who was entertained. The business discussion has to be during the activity or immediately preceding or following it.

3. Home Office Deduction.

You can deduct the cost associated with your home office, but it is getting more and more difficult. Assuming you qualify, you can deduct a proportion of expenses related to your entire home, such as mortgage payments, insurance, utility bills and home repair. A recent Supreme Court decision, until it is changed by Congress, has upheld a difficult IRS test on this issue. The space must be used regularly and exclusively for business. Second, if you are making sales presentations away from home, then the home must also be used to see customers or business associates on a regular basis. This is a tough deduction and one that you should be confident in as the risk of audit is higher.

4. Ordinary Business Expenses.

Of course you can deduct ordinary business expenses like accounting fees, advertising fees, license fees, etc. The tax advantage here is that many of your expenses may cross over between your home lifestyle and your business lifestyle, including telephone, cleaning supplies, office supplies, answering machines, audio and video equipment, fax machines, office furniture and office decorations that improve both your home office and your house.

5. The Traveling Networker.

Do you like to travel? Does your spouse like to travel? Do both you and your spouse promote your network marketing business? This is a great deduction and advantage for networkers. Of course, you are going to have to make a clear allocation between the business-related purpose of the travel and the vacation portion. Obviously, there is a gray line and it will be in your interest to substantiate as much of the travel as relating to your network marketing business. Inside the U.S., all travel expenses are deductible when the trip is "primarily" for business. When traveling abroad, you must divide the travel expenses between business and vacation time.

6. Business Gifts.

Do you have friends and family who are also customers and business associates in network marketing? The probability on this point is high. A network marketer can convert gift making, which might normally take place, into business gift making, which is eligible for a tax deduction. Under IRS rules, you may deduct up to $25 for the cost of business gifts given directly or indirectly to individuals. That should make you popular!

7. All Those Forms.

Almost every network marketing distributor agreement recognizes your independent contractor status and so does the IRS. From the IRS's standpoint, you are self-employed and you are going to pay both income and self-employment tax. If you have income greater than $500 a year, you will be making estimated tax payments as a self-employed individual. You will receive a Form 1099 from the network marketing company if you receive more than $600 in income or buy more than $5,000 of product or inventory. Your Form 1099 will be attached to your Schedule C, which in turn will be attached to your tax return. Your Schedule C will summarize your income and expenses from your network marketing business.

8. Computers, Automobiles and Capital Assets.

Here, you are going to need to talk to your tax advisor, for sure. You have some choices to make about how to deduct the acquisition costs of your computer and automobile that are used for your network marketing business. The IRS provides some very liberal limits on the amount that you can actually expense as a business deduction in any one year. Of course, you are limited in expenses to the income from your business. The other option is taking a depreciation write-off over a number of years for business equipment. Only your tax advisor knows for sure which is advantageous to you. And, of course, the costs of running your automobile for your network marketing business are deductible. You have a choice of using the IRS's standard cents per mile (in 1994, for instance, it was 29 cents per mile) or itemizing the automobile expenses, such as gasoline, repairs, maintenance, insurance and depreciation. Obviously, you need to calculate what percentage of your overall car use is devoted to your network marketing business.

9. Recordkeeping - The Name of the Game.

If you talk to the IRS, they will tell you time and time again that the most important aspect of claiming your expenses and deductions is adequate recordkeeping. The IRS will inform you to keep a separate bank account; make a record of all business transactions; and retain all your records. Recordkeeping and substantiation are particularly important for deductions for travel expenses, entertainment expenses, and gift expenses. And the IRS will always tell you that a "receipt" is ordinarily the best evidence to prove the amount of expense.

Is It All Worth It?

Should you take advantage of the expenses and deductions in the Internal Revenue Code? The IRS will tell you that those expenses and deductions are there for you as long as you don't abuse them. To serious network marketers, the expenses and deductions can both enrich their businesses and personal lifestyles, as well as mean thousands of dollars of after-tax savings in their bank accounts.

For more detailed information, including actual IRS tax rules for direct sellers, see Tax Guide for MLM/Direct Selling Distributors, Jeffrey A. Babener, Legaline Publications, (800) 231-2162.

Jeffrey A. Babener
Babener & Associates
121 SW Morrison, Suite 1020
Portland, OR 97204
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad.

www.mlmlegal.com

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