Tax Tips for Doulas
Please welcome–UH-GAIN–my husband Tim as today’s guest blogger. Last time his work appeared on Birthing Beautiful Ideas, Tim wrote about vasectomies. This time, he’s writing about taxes. Both are topics that I know little to nothing about, so I thank him for sharing his expertise. About scrotal surgery. And taxes.
I should note that when I read the draft of this post, my eyes immediately started to cross, and I think I might have even broken out into hives. As soon as I saw the words “Adjusted Gross Income,” I was all like “EWW, gross is RIGHT, tax stuff is ICKY, wash out my eyes because ME NO LIKE THIS!” So just in case you too have a moderate-to-severe case of Tax Advice Allergies, I’ve thrown in a few random pictures to pique your interest every once in a while.
(And many more thanks to Tim, my Enrolled Agent with the IRS, Attorney, and Soon-to-sit-for-the-CPA-Exams Hunk of a Man.)
It’s that special time of year! For about three months of every year, I prepare income taxes at a well-known national income tax preparation service, and with the IRS starting to accept returns as of January 30, things are starting to get busy. Before it gets too busy, however, Kristen asked me if I could write a guest post specific to doulas and the potential tax issues they might be dealing with this year. In the interests of keeping my post reasonably brief and to the point, I came up with a list of tax questions that I thought might be most pertinent to doulas, particularly doulas who are just starting out or who feel they do not have a good grasp of the tax laws relevant to them. The following is not a comprehensive or exhaustive discussion of all the potential tax issues doulas might face, and as everyone’s individual tax situation is uniquely his or her own, please review the various tax publications available at www.irs.gov and/or seek the advice of a tax advisor when preparing your taxes this year.
Q. If I am a doula, what tax forms do I have to file and how do I report my doula income and expenses?
A. Initially, you will have to determine whether the IRS considers you to be engaged in a hobby or operating a business. There are several factors the IRS looks at when distinguishing between a business and a hobby, but central to all of them is the question of whether the taxpayer engages in the activity primarily to earn income and make a profit. If the IRS determines that the answer to this question is “No,” then it will deem the activity a hobby and the taxpayer will report any income from the hobby on Line 21, “Other Income” on Form 1040. Taxpayers may deduct the expenses they incur while engaging in the hobby as an itemized deduction on Schedule A, but only to the extent that these expenses exceed 2% of their Adjusted Gross Income (“AGI”-see line 37 of Form 1040). If your hobby expenses exceed your hobby income, you cannot use the excess expenses to offset other income.
The rules differ if the IRS deems you to be engaged in a profit-making business. If you are in business by yourself (sole proprietorship), you report your income and expenses on Schedule C, and you will report the net income or loss you calculate on Schedule C on line 12 of Form 1040. If you are in business with several other doulas with whom you agree to split expenses and income, then you are considered a partnership. The partnership reports its total income and expenses on Form 1065 and issues Schedules K-1 to each of the partners reporting each partner’s individual share of income and deductions. The partners then use these K-1s to report their share of partnership income on their personal income tax return (Form 1040). Some doulas might incorporate their businesses, in which case they are required to file corporate tax returns instead.
Most doulas I’ve encountered operate as sole proprietorships, and so for the rest of this post I will assume that we are discussing an unincorporated doula operating her business by herself. If you operate a partnership or a corporation, I highly recommend you seek the help of tax advisor to assist you, as these returns tend to be more complex than an individual income tax return.
Q. I became a doula partly to make a living, but also because I really enjoy what I do and want to help new parents. How can I determine whether I’m engaged in a business or hobby?
A. In distinguishing between a business and a hobby, the IRS has delineated eight common factors it considers in making its determination, which you can view here: http://www.irs.gov/uac/Business-or-Hobby%3F-Answer-Has-Implications-for-Deductions. Keep in mind that no single one of these factors is determinative, but the IRS considers the totality of the circumstances and engages in a highly-subjective weighting process when making its decision.
Of course, a subjective eight-factor weighting process, while it provides a general theoretical framework for distinguishing between a business and a hobby, does little to provide certainty to a doula trying to decide how the IRS is likely to classify his or her activity. Mindful of this, the IRS employs a presumption that any activity which makes a profit in 3 of the previous 5 years is a business, while any activity which does not is a hobby. This presumption is not law, but the IRS has indicated that taxpayers may rely upon it to estop the IRS from making a determination which is contrary to its presumption. Since it is only a presumption, you may still argue that your activity is a business even if it did not make a profit in 3 of the previous five years by evidencing the other factors I mentioned above to show that you became a doula primarily to earn an income.
If a new business has operated for less than five years and the IRS contests its status as a business, a taxpayer may file Form 5213, Election to Postpone Determination as to Whether the Presumption Applies that an Activity is Engaged in For Profit. Upon receiving this form, the IRS will withhold its decision until the doula has five years of earnings history before it classifies it as a hobby or a business.
Q. Besides determining where I should report my doula income and expenses, what difference does it make whether my services are classified as a business or a hobby?
A. As I mentioned above, one of the key differences between a business and a hobby relates to a taxpayer’s ability to deduct the expenses incurred while engaging in the activity. If a doula’s services are properly classified as a business, then all doula expenses can be deducted on your tax return. This deduction is not subject to any limit, whereas with a hobby, a taxpayer can only deduct expenses to the extent they exceed 2% of AGI. Moreover, if expenses exceed income in any given year, with a business, the taxpayer may offset the resulting loss against other income such as wages, interest, dividends or capital gains. This may especially benefit a new doula who incurs initial expenses to start up his or her practice, but does not have a lot of clients or earn a lot of money until later on. Conversely, if you are engaged in a hobby, you cannot offset other income on your tax return with a net loss from your hobby.
Another difference between businesses and hobbies relates to self-employment tax. If you operate a business and earn more than $400 net income for the year, you will have to pay self- employment tax in addition to income tax on this amount. Self-employment tax represents an employee’s and employer’s share of FICA tax, the payroll tax which funds Social Security and Medicare. For 2012, FICA tax for self-employed persons was 13.3% calculated on the first 92.35% of net self-employment income; in 2013 FICA reverts back to to 15.3% on the first 92.35% of net self-employment income. The Social Security portion of FICA (10.4% in 2012; 12.4% in 2013) is only paid on the first $110,100 of all income earned by a taxpayer during the year in 2012 and on the first $113,700 of all income earned in 2013. Self-employment tax is calculated on Schedule SE and reported as additional tax on line 56 of Form 1040.
Hobby income, however, is not subject to self-employment tax.
Q. What kinds of business income do I have to report? Do I have to report payments I receive in cash?
A. The IRS requires taxpayers to report and pay tax on all income or property they receive during the year, regardless of the type or nature of the property they receive, unless specifically excluded by the Tax Code. This means that you need to report all income you receive as a doula, even if paid in cash.
Q. I received a Form 1099-MISC that reports Nonemployee Compensation in Box 7. Where do I report this amount on my income tax return?
A. A change to the tax law now requires taxpayers to report any payments greater than $600 they make to individuals in exchange for services during the year. The 1099-MISC is sent to the IRS and a copy is sent to the person who received the payment. A doula, for example, might receive a Form 1099-MISC from a client if they were paid more than $600 for their services. The doula should include this amount as income when completing his or her Schedule C.
Keep in mind that even if you do not receive a Form 1099-MISC from a client, you are still required to report any payments you received from that client as income on Schedule C.
Q. Assuming I’m operating my doula services as a business, what kinds of expenses can I deduct?
A. The short answer is: any expenses you reasonably incur to promote and operate your doula business. While an exhaustive survey of all the potential expenses you can deduct is not possible here, I’ll try and at least mention some of the more common ones you might encounter.
Doulas can deduct the cost of any supplies, books, or aids they purchase to educate clients and to assist at childbirths.
Doulas can deduct the costs of education or certifications relevant to maintaining and improving your doula skill-set, including continuing education courses, childbirth seminars and conferences, DONA, Lamaze, and lactation consultant certifications, etc. Eligible costs can include tuition, books, and the cost of transportation to and from the seminar or conference. If you have to travel outside your tax home to attend a conference or seminar, you may also deduction reasonable lodging and half of your meals expense while you are away from home on business.
If you have to buy special uniforms or attire such as surgical scrubs that you can’t wear normally, you may deduct the cost of these as a business expense.
Doulas may deduct any advertising or promotional items like business cards, or they may deduct the cost of building and maintaining a website advertising their services.
Q. What about the cost of travelling to client meetings and births?
A. The rules concerning deductible transportation are extremely complicated and it is impossible to summarize every potential fact pattern that might arise. In general, however, if you travel outside your tax home (the general area where you work) to meet with clients or attend births, you can deduct your transportation costs to and from the event. Likewise, if you have a home office that is your primary workplace, you can deduct transportation to and from your home. If you do not have an eligible home office, however, or if you have a primary workplace outside the home, and you are not travelling away from your tax home, you can only deduct your transportation from one meeting or birth to another; you cannot deduct the cost of commuting to from your home.
Q. How do I calculate my deductible transportation cost?
A. There are two methods available to calculate your deductible transportation if you are a sole proprietor. One method is to keep receipts showing your actual expenses such as gas, oil changes, car repairs, insurance, and depreciation on your vehicle. This requires careful recordkeeping, especially if you use the same vehicle for both personal and business purposes, as you will have to prorate your expenses between business and personal use to calculate the deductible portion of these.
Alternatively, the most common method is to keep a contemporaneous written log of your mileage to and from meetings and births. You are permitted to deduct a standard mileage rate per business mile—this amount is $0.555 per mile in 2012 and $0.565 per mile in 2013. This standard mileage rate theoretically covers business operating expenses for the vehicle such as gas, oil changes, repairs, insurance and depreciation on the vehicle so you don’t have to keep receipts fo these expenses or try and prorate them between business and personal use. When using the standard mileage rate, you are also permitted to deduct interest charges on the vehicle (in proportion to its business use) as well as parking and tolls related to business travel. Your written log should include the dates of business travel, the business purpose of the travel, the destination, and the total mileage. You will also need to note down your beginning and ending vehicle mileage for the year as well as your commuting mileage (i.e. your mileage while driving to and from your primary workplace).
Please note that if you wish to use the standard mileage rate, you must elect this in the first year your vehicle is available for business purposes. In subsequent years, you can then switch to the actual expense method if you so choose. Otherwise, you’re required to use the actual expense method in all years.
Q. Can I deduct any big-ticket items like computers, vehicles, and cell phones that I use in my business on my Schedule C?
A. Any purchased item that has an estimated useful life greater than one year is labeled a capital asset. Generally, capital assets are depreciated over their estimated useful life, which means that rather than deducting the entire cost in the year of purchase, a taxpayer deducts a portion of their cost each year until the entire cost has been deducted. For example, if you purchase a computer you use 100% for business for $5,000, you will deduct a portion of that $5,000 over five years, the estimated useful life of the computer as determined by the IRS. If you use a capital asset like a computer for both business and personal purposes, you may only depreciate the portion of the asset that is used for business; for example, if you use a computer 60% for business and 40% for personal purposes, only 60% of the cost of the computer can be depreciated.
There are several different methods of calculating depreciation, as well as special rules for listed property, which is properly such as computers and personal vehicles which are likely to be used for personal as well as business use, all of which deserves its own series of blog posts. Moreover, notwithstanding what I said above, the IRS may allow you to deduct the entire cost of some capital assets in the year of purchase by opting to use a Section 179 deduction or bonus depreciation; however, you should review the tax code and/or consult with a tax advisor before doing so.
Q. Can I deduct the cost of keeping up my home if I have a home office I use for my doula business?
A. Maybe. If you use a room or area in the home regularly and exclusively for business–for example, to meet with clients or perform important administrative tasks–you may be able to deduct a pro-rated share of your rent or mortgage interest, real estate taxes, utilities, and homeowners’ insurance on your Schedule C. To calculate your home office expense, you should complete Form 8829 and carry over the deductible expense you calculate there to line 30 of Schedule C. This is another complex topic, and claiming home office expense can greatly increase your audit risk if you’re not careful. Consider consulting with a tax advisor if you think you may have a deductible home office expense.
A. Yes. If the person was an employee of yours, you will deduct the wages you paid to them on line 26 of Schedule C and issue them a Form W-2 before January 31 with a copy to the IRS. Please remember that if the person was an employee, you are required to pay the employer portion of FICA tax to the IRS as well as withhold and remit the employee portion of FICA and federal, state and local withholding to the applicable taxing authority.
If the person was an independent contractor, you will report the compensation you paid to them on Line 11 of Schedule C and issue them a Form 1099-MISC with compensation reported in Box 7 before January 31, with a copy to the IRS. You do not need to withhold or remit FICA or other taxes on behalf of an independent contractor; however, the IRS is paying special attention to workers who are misclassified as independent contractors rather than employees. If the IRS determines that an employer misclassified a worker as an independent contractor rather than an employee, they may audit the employer’s records and assess unpaid FICA and other taxes on the employer. If you hired someone during the year to help you, I recommend you consult with a tax advisor to determine if you should classify them as an employee or independent contractor.
Q. What kind of records do I need to keep for my business and how long should I keep them?
A. There are reasons for keeping records besides taxes, and these reasons may require you to keep different sorts of records for a longer period than what is required by the tax laws. For tax purposes, you should generally keep records documenting your business income and expenses for at least three years and preferably six years. In general, the IRS has three years from the date a tax return was filed or required to be filed, whichever is later, to assess tax. This means that if a taxpayer files his or her 2012 tax return on or before the due date of April 15, 2013, the IRS has until April 15, 2016 to audit that return and assess additional tax.
The above statute of limitations, however, is extended to six years if the taxpayer omits gross income exceeding 25% of the gross income reported to the IRS on a previously filed tax return.
If you never filed a tax return with the IRS, or if the IRS uncovers evidence that the taxpayer intentionally misstated income, deductions or credits, there is no statute of limitations and the IRS may assess additional tax at any time.
Even though the general IRS statute of limitations is three years, the IRS is continually lobbying Congress to extend this period to six years; as such, I recommend that you keep your tax records for six years if possible. Moreover, different states and local taxing authorities may observe a different statute of limitations; for example, in Ohio, the general statute of limitations is four years.
Records you keep should include evidence of all income, including W-2s and 1099s, copies of client checks and contracts, and bank statements. Evidence of deductible expenses should include receipts for food, lodging, and any business purchases, a contemporaneous written log documenting transportation and travel expenses, contracts, bank statements and copies of cancelled checks. Credit card statements are generally not sufficient to evidence an expense, but they may be used, in conjunction with other evidence, to reconstruct expense records if receipts are lost or destroyed.
Q. What about state taxes? Local/city taxes?
A. Generally, most states and cities follow the rules I outlined above regarding the reporting of business income and expenses; however, each state and city has their own unique tax laws and policies, and a discussion of all of these distinctions is not possible here. Please do your own research or consult a tax advisor to discuss the state and local tax rules that apply to your case.
I hope that some of you find that the above information at least gives you a good starting point when it comes to planning for taxes and preparing your own returns. Please remember that the above discussion is not intended to be comprehensive or authoritative; rather, you will need to do you own tax research or consult with a tax advisor to discuss your own situation. If you have additional questions or need clarification, feel free to email me at firstname.lastname@example.org.