According to the IRS you are a private contractor employed by Google
etymonline.com
etymonline.com
There is a impedance mismatch at work in our system of governance that's not going away any time soon. The government makes laws by sticking people into little boxes and making rules for those boxes. This system of boxes and rules -- the tax code -- is becoming more and more removed from reality by the day.
You make 10K a year selling things at yard sale, nobody is the wiser. You make 10K selling pot, nobody is the wiser. You make 10K by putting little bits on a server somewhere, you're a business. Why? Because Google can report you, that's why.
You buy socks from Amazon from a house in one state, you have to pay taxes. Buy the same socks from another state, pay no taxes. Order overseas, no taxes no matter which state you are in.
In fact all of these are businesses -- or none of them are. It's like arguing about how many angels can dance on the head of a pin. We have this word "business" which has some kind of vague meaning, so we attach a bunch of rules to the abstraction.
We have a 1900s view of how things work that we are desperately trying to take a hammer and pound into a 21st century reality.
In point of fact, the economy works because people are constantly adapting to new circumstances, trying to do the best they can. As the rules get more and more complex, more and more people will end up being quite surprised at the situation they end up in.
Personally I think the system is broken beyond repair -- too many politicians are architecture astronauts -- but however it turns out, I have immense sympathy for the author of this article.
Probably the closest "real world" example would be a flea market. Those large flea markets are the google, and the vendors are the independent folks putting ads on their sites. You sell $10k worth of goods at a flea market, you bet your ass that market will have the mechanisms in place to ensure that the IRS knows.
It's the same thing here.
http://marijuanastamps.com/state-stamps.htm
Mostly, it's another way for pigs to steal from people. The idea being they can not only throw you in prison for dealing, but then use tax forfeiture laws to take everything you own.
The best you could hope for is some sympathy from the judge and/or not also getting slapped with tax evasion.
Source?
That's not to say that 10,000 USD annual revenue is too low to be efficiently taxed; but there certainly are points at which it doesn't make sense.
Do you think $50/month is worth all these paperwork? I sure don't.
As a small-business owner myself, I can sympathize with the OP about having to get all businessy with his website. Being a small-business and "doing it right" can be a lot of work. You either do the work yourself, or you pay someone to do it. There are plenty of ways to go wrong if you're not on top of it.
Further, you conflate taxation laws and laws that prohibit things, eg "trading with each other is a taxable offense". In the real world, someone has to pay for the government and businesses pay a piece of the cost.
This is also stupid on its face. The market needs the government if only to ensure that bad actors don't corrupt it.
The government also promotes bad IT practices overall.
This is not entirely true, I ordered a good deal of hand carved furniture from India one time and a hand carved bed from China another, both times I received a letter from the State of Florida letting me know exactly what I owed the state in taxes.
One anecdote about is not an indictment of the whole system.
One killing is not an indictment of the whole person.
Just because something works OK (not great, but OK) in the average case doesn't absolve it of terrible behavior in less common cases.
It isn't quantum mechanics. The rules which the OP professes not to understand boil down to this:
1) Everyone owes income taxes and Social Security/unemployment ("FICA") taxes on all of their income. To restate this in a fun but cartoony way: everyone is a "business". [1] No philosophical debate necessary.
1a) Except: If you get a W2 form along with some of your income, that income already had the FICA taxes paid on it (and, if the estimate is accurate, most of the income taxes, too). This feature is designed (among other things) to make the accounting so easy for most people that, if they are minimally numerate and are willing to actually read the IRS instructions, they can pay taxes with a one-page form without hiring an accountant.
1b) If you can't understand what I have said so far, hire an accountant.
2) If you earn more than a few hundred bucks without getting a W2 form for it, you owe FICA taxes. If you can't or won't figure out what Schedule C is, hire an accountant. [2]
3) Business expenses are deductible. If your non-W2 money is going right back out the door to pay business expenses, you may owe nothing. Keep track of those expenses (throw the receipts in a box, buy everything on a special credit card, hire a part-time bookkeeper, or -- god help us -- learn how to keep an account book). Then declare them; if you can't figure out the forms, hire an accountant.
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Still too abstract for you? Here's rule zero:
0) Hire an accountant. Do what the accountant tells you.
One hour of accountant time, at any point over the last few years, would have been enough to save the OP.
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Now we are in a position to discuss your other point: Why do people often get so harsh when folks propose to "simplify" the tax code?
Let's not ignore the elephant in the room: Mostly, it's because so few of these proposals are in good faith. Most of the tax-related writing that crosses one's field of vision is the direct or indirect result of politically-motivated lobbying efforts by individuals who are trying to lower their own taxes relative to others. We try to block these for the same reason that we block spam.
But another reason is that many people want to pretend that accounting isn't important. They ask: Why does there need to be so much accounting? Why can't life be simple? These are very likely the same people who don't understand the need for so much computer programming. Shouldn't computers just be simpler? Can't we just write it all in Visual Basic? Can't it all be done by kids on minimum wage? Can't we just hand it all over to Microsoft and let them handle it? Why can't we just outsource all that stuff to some foreign country? Why can't computers program themselves? Shouldn't it all just "work"? Weren't things so much better back before we had all these terribly complicated things like the personal computer?
It gets tiresome. Society is complicated. Deal with that. Learn basic accounting, or hire someone who did.
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[1] Note: I am not an accountant and you should hire a real one. You can detect the real ones by the moan of despair that they just made when they read my last sentence.
[2] I can, but I won't. Accountants are not expensive relative to my time. In fact, they have an astonishing tendency to pay for themselves.
Actually, this isn't true; the Social Security portion of FICA (which is most of it) is only paid on the first $106k of your gross income (in 2010). Additionally, the word "income" in your sentence reveals some very complex questions about the differences between gross revenue, gross income, modified adjusted gross income, etc. The "income" against which you pay taxes can vary greatly from the actual cash coming into your bank account, thanks to a variety of deductions and credits. I own real estate that produces positive cashflow but I take a "loss" on it every year according to the IRS, offsetting some of my other income.
Your best advice here is to hire an accountant :)
Obviously, my pocket-sized rule of thumb isn't designed for people who earn $100+K per year. Those people can afford accountants. Likewise, people for whom adjusted gross income is a necessarily complex calculation involving the phase of the moon can probably also afford accountants; if not, they need a simpler or more profitable financial plan.
Hiring an accountant isn't a particularly difficult thing to do. They're on every street corner. In the month of March, you'll find people dressed in costumes standing at the side of the road, advertising them. [1] And even the robot tax accountant built into Quicken Online was pretty good, in my limited experience. Would Quicken Online have caught the OP's FICA problem? I don't know, but quite possibly. I've never tried to declare substantial quantities of non-1099, non-W2 income in Quicken before, but you'd think it would at least pop up an ominous dialog box.
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[1] A friend of mine had this job once.
I had been declaring that ad revenue as "extra income" and dutifully paying my taxes on it. Suddenly last year the IRS informed me I owed them scads of money that I didn't have. Still, it's nice to know the IRS has time and resources to squeeze both me AND the guys who brought down Wall Street. Oh, wait, those guys are still swilling Chivas in their gated burbclaves.
It's true that American education does a pitiful job of impressing upon the average citizen that (a) accountants rule the world; (b) you should therefore take a basic accounting class, and/or pay attention to the words in those IRS instructions that the government carefully mails to you every year; and (c) you should talk to an accountant for an hour every few years, unless you can't afford that, in which case you should probably still try to find a way to talk to an accountant, pro bono or something, because they might be able to help.
your programmer analogy is interesting. the problem with democracy is you are always mending a legacy system. you can never start over because of existing special interests who are benefitting. this feature provides stability. but it also means no chance for real innovation. all democracies have this problem of spaghetti code laws. places with less democracy can innovate -- places like singapore. obviously there are some draw backs to less democracy. but there can be benefits too
If people understood their best interests and elected officials acted on behalf of those best interests we would have a simpler tax code. The opacity of law benefits only those who can understand it. Clarity of tax code is simply not in the interest of those who pay for laws to be drafted.
But, did he remember to track and deduct all of his expenses? The flipside to that income is that the server costs are all deducted from it. If he really was "just barely covering costs" with his Google ads income, it should be 15.3% of nearly zero dollars. He may even be owed a refund if he was paying full income tax on the ad revenue without deducting server costs.
I am not an accountant, but I've dealt with SE tax and had a few "conversations" with the IRS in the past. For all the worries about them being biased, I've found them to be fair, as long as you have precise documentation.
This is an entirely reasonable mistake because that is the correct way to do taxes on unearned income like interest. Only earned income is subject to social security and medicare.
I'll email him shortly later today to offer my help directly. But I'll post a few thoughts just so that anyone else in a similar position will be prepared.
Everyone pretty much hit the mark with the self-employment tax issue. SE Tax is a 15.3% tax that you have to pay on income earned from a business.
It sounds like the etymonline guy pretty much got hosed from paying income tax on the income but failure to pay the SE Tax.
Google issues 1099s to anyone that earns over 400 or 600 dollars so the IRS knows if you're making money.
But, from the sound of his explanation. His server and upkeep costs should've generated enough expenses to wipe out his income. I'd have to speak with him directly and more in depth but that is the impression he left in his plead.
Also, there are ways to avoid paying SE tax entirely. If you incorporate into a S Corp and pay yourself a reasonable income, the rest would be excluded from SE Tax. An Scorp is a passthrough entity which means that all income is not taxed twice like a regular Corp. You pay tax on the income once on your 1040. But because the scorp is still a corporation, then you wouldn't pay SE tax on that income because the distribution is a dividend. You don't pay SE taxes on dividends.
Also, it seems like the taxpayer isn't clear about his options once the audit has commenced. Luckily, I'm sure that the taxpayer could still plead his case if he has some facts that could help his situation.
But these are my initial thoughts on the situation. I'm going to email him now and see if he's interested in discussing the issue further.
I'll update everyone on this issue later on if he is willing to allow me to speak on the matter as a learning experience for everyone.
Why do I feel like noting this could have saved more than a few words in the article; at the very least, how was it that this salient fact is never mentioned?
> Also, there are ways to avoid paying SE tax entirely. If you incorporate into a S Corp and pay yourself a reasonable income, the rest would be excluded from SE
Ditto. This one note seems a much more valuable takeaway than most everything in the article.
Not trashing the article, just that camz nails the important points with a greater economy of words.
Becoming a corporation will not reduce your taxes, but it will significantly increase the complexity. The main benefit it liability, not financial.
I could point you to a number of resources to clarify the issue, if your interested?
On way or another the full 15.3% social security tax is going to be paid.
An S-Corporation is a standard C-Corporation that has elected for special treatment. Instead of paying double taxation, its income is directly passed-through to the taxpayer. But, that does not change the character of the income. The income is still considered a "corporate distribution" or a dividend. Thus, it cannot be cannot be taxed under SE Tax rules because a dividend is not "self-employed income."
This rule is found at IRC § 1368 (c)(2) :
In the case of a distribution described in subsection (a) by an S corporation which has accumulated earnings and profits—
1368(c)(1) Treatises Accumulated adjustments account.
That portion of the distribution which does not exceed the accumulated adjustments account shall be treated in the manner provided by subsection (b) .
1368(c)(2)Dividend.
That portion of the distribution which remains after the application of paragraph (1) shall be treated as a dividend to the extent it does not exceed the accumulated earnings and profits of the S corporation.
1368(c)(3)Treatment of remainder.
Any portion of the distribution remaining after the application of paragraph (2) of this subsection shall be treated in the manner provided by subsection (b) .
I hope that this has been helpful! =D
By the way, it's great to see a qualified member of the HN community offering help to Etymonline. Do let us know if anything comes of it (he's says he's made contact with a local tax lawyer, but based on your reputation here, I'd rest easier if he were in your hands ;-).
I've yet to hear back from him, so I haven't had anything to update. I'm guessing that he feels comfortable with the information he learned from the tax attorney and is satisfied with the help he's received.
In regards to the "reasonable salary" issue that's a difficult topic to explain because its a subjective test. The word reasonable is going to be very different for the IRS compared to the average taxpayer.
In my experience, a "reasonable salary" is going to depend a number of factors. The best way to prove that you're getting a reasonable salary is to have "comps" or comparable positions with the same functions and them take the average of their salary.
Ex: Your job description is an entry level developer. Average salary is in the range of 55k to 75k but the mean is 60k. In this situation you could argue for any salary between 55k and 75k, but the clearest answer would've been 60k. Subjectivity please a big role in this area.
Also, experience has given me a "gut feeling" on what is reasonable so often times I go by just guessing based on what I've seen on the past.
Lastly, thanks for the props! I'm honestly surprised that anyone even bothers to read my posts about boring tax loll but I'm glad to have been of help =D.
Unfortunately, those minutes would have been a bunch more helpful before he ended up with penalties for not filing, but again, a good tax professional can probably help him negotiate a more reasonable settlement.
It's unlikely that the IRS will do anything drastic in his case. He'll probably just go on a payment plan and figure out how to move forward with his website. They'll work with him.
But this person, if they put the brakes on the conjecture and so on, and instead go talk to an accountant, can probably get it all taken care. It will take work; it will probably be necessary to refile the last N years of taxes with the appropriate form on which to list both the business revenues, and business expenses (of which it sounds like there were plenty). He may even get some money back.
Of course, doing that work is much less fun than venting.
1) Vested interests that like the tax system the way it is.
2) Envy and fear of envy. People who think the income tax takes from the rich, and people who happily pay their fair share because they have guilt feelings about their level of income, and think others should too.
3) The last reason is the overwhelming majority think of the income tax system as THE natural and logical system for raising revenue, having no clue about how it came into being and evolved.
Google "fair tax" for one such proposal.
My family, for example, puts far more money in the stock market than they do in groceries every month.
You'll spend some, invest some, etc. You'll also have kids, so even if you save it all, it'll get divided amongst more and more people.
Or you'll give it all away to charity.
Just look historically - are they any wealthy families that kept all the money in the family and never spent it?
I don't think there are any that even lasted 3 generations before it was spent or diluted among many children.
My family tends to put a fair share of its yearly spending into family vacations, also, which wouldn't generate any taxes for the United States. This isn't really about my family though, it just doesn't make sense that you would rely on "eventual" wealth dissipation in order to collect taxes. Also, would you seek to tax different items differently? It seems like it would be more difficult to find and tax luxury items differently than simply using a progressive income tax. Would you have to establish VAT for items imported to the country? Would this be double taxation if you bought a good which has a VAT tax in another country?
The Walton is just now reaching it's 3rd generation, so isn't that old.
If this part really bothers you, you can have a sales tax plus estate tax, but no income tax.
BTW, you are asking me a bunch of questions on the details, when none of this is my idea. I'm just parroting what the proponents of the "Fair tax" say.
Reading his paper it seems like this idea has some merit but this implementation is also fairly suspect.
I will argue for an alternative that is far more efficient and retains progressive elements.
In the U.S. the tax collection points number in the 100s of millions. This incurs cost on the sovereign, reducing the value of the collected revenue, and on the taxpayers, increasing the burden of the tax. It makes much more sense to switch to a system where the tax collection points number in the 10s of thousands, and the rules are transparent.
Public utilities are already extremely efficient tax collectors. Take a close look at your utility bill. The taxes may have confusing names, but they are there, and the utility collects them and remits them to the sovereign with very small staffs implementing very simple rules (compared to the IRS tax code).
Bear with me, I am now getting to the meat. Think of an energy transformation tax. Whenever energy is transformed (in most cases combusted), it is taxed. Somewhat like a value added tax, but only for energy. For instance, coal at the electrical generator: taxed; natural gas to heat a building: taxed; gasoline or diesel pumped into a vehicle:taxed; electricity at a meter: taxed.
Utilities are already set up to do this. Just bring on oil and coal companies and a few others. Those are your tax collectors.
Social justice / progressive tax? The utilities are also already set up to do this. So-called life-line or base-line rates on bare minimum consumption don't get taxed. Likewise a minimum level of gasoline and diesel consumption could be tax free to individuals.
Energy consumption underpins virtually all economic activity. There is no escaping taxes in the underground economy. Energy theft can be made a special case of crime with appropriately draconian punishment.
And do you really want to soak the rich? What do you think their energy footprint looks like compared to the common man's? Even when all they do is clip coupons.
Concerned about rising CO^2 levels? Tax hydrocarbon conversion higher than others. That which you tax you get less of. That which you subsidize you get more of.
The economic analysis of tax rates on different fuels is very feasible compared to analyzing the entire economy. I don't underestimate the capacity of elected politicians to complicate and demagogue anything, but an annual debate on energy conversion rates would be far more transparent than the budget process.
Of course it would be a big shock to jump to such a system in a single year, and this has only been a brief outline of such a plan. Better to implement over several years and dedicate the IRS to catching tax cheats from the old (income-based) system while it is mostly phased-out.
On average the rich use energy more than average people, but the proportional difference isn't huge, and it's pretty safe to assume the top 1% of earners aren't consuming anywhere close to 20-30% of household energy.
Replacing income tax with a levy on energy would be regressive beyond belief, to the point where I don't think it would be possible to match the returns generated by the current system and maintain a minimum tax-free level of fuel consumption that would allow the average person in some states to stay warm and be able to travel to work on a daily basis.
And this is coming from someone who gets by comfortably paying approx 4x the fuel tax Americans do...
More importantly, such an energy based tax system would result in the vast majority of tax being remitted by business and institutions, not individuals. Businesses would not be able to avoid taxation through accounting tricks, but at the same time the cost to business of paying tax would be eliminated because it requires no bookkeeping. Like all taxes on business, this reflects in cost of products and services. Less energy intensive products and services become more competitive on cost.
The fundamental fact is that the poor do not make enough money to pay for all this. Further, it is the wealthy that most benefit from the government's services -- without the roads, without the extensive police network, commerce would be much more difficult.
Thus, it makes sense that the wealthy, who are most able to afford taxes, would pay for most of it. (When you tax someone to the point where they cannot afford food or shelter, you will see revolution and civil war. Few make money in that situation.
Thus, progressive taxes are the most likely in a wealthy society. (Feudalism works on regressive taxation as an alternative.) Income is one of the easiest methods of progressive taxation.
1) Everyone's earned income below about $105K has an additional 12.1% tax called Social Security. Half of that is disguised as the employer contribution, but it still has an impact on the economic activity available to poorer people in terms of wages offered, and even the number of jobs offered. Social Security benefits are paid from the general fund, and Social Security taxes are paid into the general fund. This is a regressive tax. The only distinction is the benefits you eventually draw are somewhat determined by your contributions.
2)The truly rich (I'm not talking about couples in expensive metropolitan areas earning $250K) have the luxury of great discretion in regards to when, how, and even IF they take income.
...and we haven't even talked about the underground economy, which by definition does not pay income tax.
...and let us not forget all the tax cheats, the greatest of whom got a Presidential pardon. http://en.wikipedia.org/wiki/Marc_Rich
It is pretty clear that he should have been deducting his expenses from the site and only reporting the profit as self employment income. If he was actually making $10k in profit, then he should have been aware that it was more "business" than "hobby" and used those rules.
For those not familiar, the IRS has a category for a hobby because some people may have a hobby that looks a lot like a business that loses money. You can't deduct losses against your outside income, as you can in a serious business that just happens to have not made money that year.
Not a lawyer, not an accountant. Just someone who can read.
The sorry fact is while you may think your tax rate is 15% or 25%, there is always that extra 15%, even for the employed. In employee's case, they pay half (FICA) and the employer pays half, which of course reduces real earning potential by that amount. It's a scam to talk about taxes rates and only quote the federal income tax rate.
The problem with this sort of thing (and the new 1099 rules) are that they criminalize a large swath of the population. Sure, the violations are minor, but the fact is if you break the rules you are guilty of a crime.
The problem with this is that if we're all already guilty then it gives enforcement officials too much power over us.
"Did you really think we want those laws observed?" said Dr. Ferris. "We want them to be broken. You'd better get it straight that it's not a bunch of boy scouts you're up against... We're after power and we mean it... There's no way to rule innocent men. The only power any government has is the power to crack down on criminals. Well, when there aren't enough criminals one makes them. One declares so many things to be a crime that it becomes impossible for men to live without breaking laws. Who wants a nation of law-abiding citizens? What's there in that for anyone? But just pass the kind of laws that can neither be observed nor enforced or objectively interpreted – and you create a nation of law-breakers – and then you cash in on guilt. Now that's the system, Mr. Reardon, that's the game, and once you understand it, you'll be much easier to deal with."
(The gift tax applies to the giver, not the receiver.)
1. If he runs Adsense, he's not going to get casino or penis ads. Last I checked, Adsense was pretty strict about that.
2. Asking users for donations is hardly begging. He's providing (one hell of) a service in return, so it's only fair.
I've seen this before. People reviling the notion of associating money with the service they provide, and eventually running into money trouble sooner or later.
Even if Douglas chooses to go down the nonprofit road, he'll still have a much harder time than if he just declared etymonline.com a business and ran it as he saw fit.
I'm not sure CPA is needed (my rule is >$100k total income, use a CPA else just a 'tax attorney'/'accountant' type person). But someone who understands these things would be helpful.
You have your regular w2 form's amount from work. Any additional money you tacked on as additional income, the tax professional would have questioned where this extra money is coming from.
He or she would have identified that you got extra money as a business (you do not need a business license) but you must file this in a different form and pay the appropriate taxes (including social security, medical, and the other business-related taxes). The tax professional would have asked you for possible deductions and you could have deducted all your business income from it.
There's nothing unfair about this. IRS is doing the right thing. It's really your fault for getting a crappy tax professional or for doing your taxes yourself. And to add, tax professionals aren't even that expensive.
Can anybody recommend any good resources for information to help me avoid situations like this chap has got himself into?
They have a lot of good, basic information explained well.
No one else can really do that for you other than your accountant.
I know the revenue share pitch is a big old red flag for any developer worth their salt (most people who want to do a revenue share have some sort of scammy half-baked idea with nothing else to offer for which they want half of the revenue).
But this guy is clearly bringing something important to the table (a curated database of etymological data), and the app wouldn't be that complicated (depending on whether the database ships with the app or is lazy-loaded from the server).
The IRS usually takes 3 years to find a mistake like yours. It sounds like you've been filing wrong since 2005. The penalties suck but you got to keep that extra 15% for a really long time.
Most importantly, you have a really long time(6-12 months) from your initial notice from the IRS, before they start trying to collect. You couldn't pay right now even if you had the money, that was my experience anyways. I received a different letter from them, months later, and was finally able to pay.
Everyone knows you don't mess with the IRS. I don't get how you did this wrong for 6 years, never researched it, asked someone, or talked to an accountant. My gut tells me you probably knew what you were doing.
If you aren't trying to make money, you may be able to report it as a hobby, deduct your expenses and avoid self-employment tax.
There is a reason why Google sent you a 1099 form and not just an account statement, after all. Now you know what it is. No need to whine about how it's some sort of conspiracy -- you sell your time to someone, you're a contractor, you made income, and you pay income taxes. It's very simple.
The rant about the "financial crisis" was also off topic. Selling insurance really cheaply to people that you should be selling it to for a lot of money is not the IRS's problem. When the banks can't loan money or give back deposits, though, that is a problem, and that's why they got bailed out. Most of the banks paid back their money years ago. TARP is over. You got your money back. Now you need to do your part and pay what you owe the government.
(Whenever I write an article and it ends up in the tone of voice that the poster's ends up in, I realize that I fucked up and I'm not going to get any sympathy. I hope the author also learns that lesson. You make mistakes -- fix them, don't whine about them. If you want a new tax system, run for office. Your blog is not going to change anything except the public's perception of you.)
It does cost a few 100$ every year, but if you get income from anything other than W-2 jobs, you'd better have an accountant.
I've definitely had little accidents in my filings and minor trouble with the IRS but my experience is that, with the help of an accountant and some common sense, these problems can be worked out easily