IRS wants its due from moonlighting, but it still offers write-offs
Boston — ''It's easy to work for yourself. The IRS is on your side.'' Go ahead and laugh at that statement, says James Sullivan, a financial planner in Acton, Mass. But the fact is, the Internal Revenue Service actually likes moonlighters, he says. The more money you earn, the more taxes you pay.
Moonlighters and free-lancers do have an image as people who work ''off the books''; that is, taking payment in cash, not keeping exact records, and not reporting some or all of their extra income to the revenuers. Although some people may do this some of the time, the vast majority, Mr. Sullivan believes, do pay their taxes, however grudgingly.
There are two key things to remember about taxes on extra earnings. First, any money you make from moonlighting is income and must be reported to the IRS. Second, while some rules regarding deductions have been tightened, there are still plenty of areas where the government helps free-lancers by letting them write off business-related expenses and declare losses for a few years while the venture gets started.
''Deductions for individuals are very specific and getting narrower all the time,'' Sullivan says. ''But business deductions are staying quite general.''
One thing a person starting out needs to know is the difference between a business and a hobby. Strictly speaking, the IRS will allow you to lose money three out of five years. Any more than that, Sullivan says, and the venture is considered a hobby, and business deductions cannot be declared.
The government is somewhat flexible on this point, Sullivan notes. It recognizes, for instance, that some businesses take longer to get off the ground , so while yours may lose money for the first four or five years, or a few more, you may still be able to take the business deductions, if you can show ''profit potential.'' In other words, is the business growing and are you investing time and money in it in such a way as to lead eventually to profitability? And are you making a continuing effort to market and sell your product or service?
Some free-lancers, like writers, can even document their development from loss to profit: ''Keep your rejection slips as evidence that you're serious about it,'' says William Whalen, director of publications at Purdue University and a free-lance writer.
One way to help show your good intentions, Sullivan suggests, is to take out an ad in the Yellow Pages and have some business cards and stationery printed. ''Make it look like a business,'' he says.
Once started, you have to decide what category of business - sole proprietorship, partnership, or corporation - you want to be. Stick with proprietorship in the beginning, Sullivan says. It's the least complicated and easiest to start. The first time you sell something - whether it's a basket, clay pot, short story, or your time - and take money or bill someone for it (as distinct from receiving a wage or salary), you are a sole proprietor. Partnerships and corporations require legal work that an individual starting his or her own business is better off leaving alone. Later, when the business is large enough to need the legal protection offered by a corporation, this route can be considered.
Filling out the extra tax forms is another of those privileges that go along with having your own business, however small. If you are running a business out of your home, watch for this line on your Form 1040: ''Business income (or loss) (attach Schedule C).'' Schedule C is where you report all your moonlighting income and list all the expenses you expect to deduct from that income. If the acceptable deductions are greater than your income, you will have a loss for the year. If your business requires any equipment, such as a typewriter, desk, loom, clay, or automobile, you will also need Form 4562 for depreciation and amortization.
Contrary to the impression some people may have had recently, the IRS will allow you to deduct part of your home if it is used for the business. But if you have the impression the service is hewing to stricter guidelines on this point, you are correct. The room or corner of the room where you perform the business must be used exclusively for this purpose. ''You could even have a studio apartment and use a corner of it for your office,'' Sullivan says. ''Just figure out how many square feet you're using for this'' and subtract that from the total number of square feet in the apartment.