The most serious problem facing U.S. taxpayers is the complexity of the Internal Revenue Code.
That’s not just my opinion. It’s an actual statement from the IRS!
According to the same IRS report where I found that statement, an analysis of IRS data uncovered that U.S. taxpayers and businesses spend about 7.6 billion hours a year complying with the filing requirements of the Internal Revenue Code.
And that figure does not even include the millions of additional hours that taxpayers must spend when they are required to respond to an IRS notice or an audit.
Compliance costs are huge — both in absolute terms and relative to the amount of tax revenue collected. Based on Bureau of Labor Statistics (BLS) data on the hourly cost of an employee, it is estimated that the costs of complying with the individual and corporate income tax requirements in 2006 amounted to $193 billion (or a staggering 14 percent of aggregate income tax receipts!)
The tax code has grown so long that it has become challenging even to figure out how long it is. A 2005 report by a tax research organization put the number of words at 2.1 million, and notably, found that the number of words in the Code has more than tripled since 1975.
So as you can probably tell, I’m not a fan of April 15th. I know we can do better as a country — much better! (Personally, I think the FairTax is the best viable solution to replace our broken system.)
But since we’re stuck with the system we currently have (for now!), we have to figure out how to navigate the ins and outs.
In this episode, I’m going to attempt to help you do that by asking my guest a bunch of questions you guys told me you wanted answered. My guest is Trevor McKendrick. Trevor started Salem Software, a developer of Spanish-language iOS apps. He grew it to over a million users and finally sold the company in 2015. He’s been featured in the Startup podcast, the Huffington Post, Business Insider, Fox News, Fast Company, and numerous other publications.
He also holds a master’s in accounting, and just recently created an accounting essentials course for entrepreneurs and freelancers. You can find Trevor and info on his accounting course at TrevorMcKendrick.com.
The notes that follow are a very basic, unedited summary of the show. There’s a lot more detail in the audio version. You can listen to the show using the audio player below. Or you can subscribe in iTunes to get this show delivered straight to the Podcasts app on your smart phone, tablet or iPod.
NOTE: The podcast audio and show notes for this episode (and all episodes) are provided for general information purposes only. They do NOT constitute legal or financial advice, and we make no warranties about the completeness, reliability or accuracy of this information.
Consult with an accountant or other financial professional before making any financial decisions or taking any actions regarding your taxes or personal/business finances.
Tell us about yourself
Trevor holds Bachelor and Master degrees in accounting. After graduating, he worked as an auditor in the Silicon Valley for a number of years.
In 2012, he started a software company that created Spanish language iPhone apps. He sold the company last year.
What are self-employment taxes? And how can we reduce them?
When you’re self-employed, you’re both employer and employee. So you have to pay both portions of self-employment taxes.
You can reduce the amount you have to pay by making an S Corporation election when you file your taxes. (Your accountant can walk you through the process.)
Why does filing as an S Corp reduce our payroll tax liability?
Self-employment taxes are calculated on your payroll (what the business pays you). With an S Corp, you pay yourself a salary (on which you pay self-employment tax), but you don’t pay self-employment taxes on profits beyond your salary.
What kind of things can we deduct?
Generally, anything you pay for in the course of conducting business is deductible.
But don’t try to memorize a list of what’s deductible and what’s not. Instead, hire a bookkeeper.
Hiring a bookkeeper is relatively inexpensive and will save you a lot of hassle at tax time.
Bookkeepers will know how to classify your expenses. And they’ll make things easier for you and your accountant.
Tell us more about the home office deduction
You can deduct your home office if it’s used exclusively for your business.
You can also deduct a portion of your Internet, utilities and rent/mortgage interest (with no double dipping). The portion you can deduct is based on the square footage of your home.
What are the advantages/disadvantages of buying vs. leasing a car as a business owner?
From a tax perspective, it makes no difference.
You can deduct your car in one of two ways: track all expenses related to your car or track your miles. If you choose the expenses method, your lease or purchase costs are part of your deduction.
Generally, it’s easier to track your miles.
When does it make sense to incorporate?
It’s not something you have to do right away. But once your business is generating a significant portion of your personal income, then you should consider it. Incorporating helps protect your personal assets from business liabilities.
Does a LLC incorporation protect your assets better than an S Corp incorporation?
Both give the same protection as long as you keep your personal and business expenses separate.
Of the two, LLCs are more simple and flexible. They have fewer reporting requirements and are cheaper to run. You get all the legal benefits of an S Corp with less administrative burden.
What are estimated taxes? How can we estimate them if it’s our first year of freelancing?
The IRS wants to make sure you can pay your tax bill at the end of the year. So every quarter, they require you to withhold a portion of your estimated taxes.
If it’s your first year of freelancing, you can use the amount of taxes you paid last year as the basis for this year’s estimate.
How can we avoid being surprised by a huge tax bill at the end of the year?
People tend to underestimate how much they have to pay. It’s better to overestimate.
Transfer these funds into a separate account as you receive them.
Also, tracking your net income every month will give you a good idea of your tax bill.
When should we start putting money away for retirement?
Earlier is better. Don’t underestimate how much you’ll need to enjoy a decent retirement.
Self-employed people have some great options for retirement that aren’t always available to those traditionally employed.
Check out Trevor’s blog post on this topic.
What can we do to avoid an IRS audit?
Self-employed people get audited more because they’re more likely to make mistakes on their returns.
If you claim a home office deduction or file as an S Corp, you’re more likely to get audited.
There are four types of audits. Some are more serious (and more hassle) than others. But you’ll be fine as long as you’re upfront and doing things correctly. Ask your CPA to help you.
What should we look for when hiring an accountant?
Look for someone who has clients in your industry or a similar industry.
Ask people in your industry for referrals. Thumbtack.com is another place to check.
Ideally, hire a CPA who’s recently left a large firm to start his/her own business. He/she will have good experience and value your business.
Where can listeners learn more about you?
Trevor’s website: trevormckendrick.com
Trevor offers an accounting course for freelancers and contractors. Learn more about that course here.