Can I classify as a sole proprietorship?

[gdgross]

Hi all - I’m getting hammered by the cap on job related expenses in my itemized deductions this year. 

I understand if I’m classified as a sole proprietorship, I can still itemize. My question is, is hat worth it for my situation, and if so, which version of TurboTax do I need? (I purchased the deluxe version because that’s what I’ve always used in the past.) 

We are musicians with day jobs: were in CA, Married (filing jointly, although not opppsed to individual filing if it’s better), one child, w2 income in the 80k range, and 1099 income in the 30k range from performing in 2018. 

In the past he jo related expenses deduction has really saved us, we do have lots of them due to the nature of our work. I understand that there’s a cap on that this year of 2% of your AGI. Is there any way to reclassify ourselves to avoid this and be able to take the deductions? Sole proprietorship? 

Thanks!!

[Carl]

A self-employed person who reports their income on SCH C as a part of their personal tax return is either a sole-proprietorship, a single member LLC or a contractor. For tax purposes, the only difference between those three is the spelling.
If your income is reported on a W-2 and the "statutory employee" box on that W-2 is not checked, then you are not self-employed for that income. Period. You don't get to chose here.
"I’m getting hammered by the cap on job related expenses in my itemized deductions this year"
What cap? There is no cap. W-2 job related expenses are just flat out not deductible at all starting in 2018. But then, maybe you're referring to a state return possibly? I can't speak for any state return.

[gdgross]

Thanks Carl - it’s the job related expenses for the 1099 income, not the w-2. 🙂

Thanks!

[Opus 17 · Accepted solution]

Your job classification depends on your relationship with your employer, you can't change it on a whim.  

If you have unreimbursed job expenses from your W-2 job, you should discuss reimbursement with your employer.  In some states, if you are required to pay certain costs and are not reimbursed, that may be a labor violation.  You can't get any tax benefits for unreimbursed expenses from a W-2 job.

For self-employment income (side jobs, gigs, etc.) you report your income and expenses on schedule C, that expense deduction was not changed in tax reform.  However, you can't allocate expenses from one job to another -- you can't allocate expenses from your W-2 job to your schedule C, even if they are the same kind of work.  For example, you can't deduct mileage from your W-2 job on schedule C, although you can deduct the mileage to and from your side gigs on schedule C.

Remember that each spouse needs a separate schedule C for their own part of their SE income. 

Some costs may be difficult to allocate.  For example, if you buy a new instrument, can you list it as an asset on your schedule C and depreciate it, or do you only depreciate 50% of the cost, if 50% of your income is W-2 and 50% is self-employment.  I'm pretty sure you have to allocate everything, but you would need to speak with a professional accountant for a definitive answer.

[gdgross]

Thanks Opus - yeah I realize that you can't deduct job expenses from the W-2 income, this would all be related to the 1099 income.  Instruments, website fees, strings, picks, mileage to gigs, part of my phone bills that are used for business purposes, etc.  

I've always deducted these kinds of things in past years, but it looks like to be able to do it this year I will need to classify myself as a small business/sole proprietor, as the new tax code limits unreimbursed job expense deductions to 2% of your AGI.  I suppose I never realized that I wasn't a small business before; I'm not sure if Trubotax classified this as hobby income or what.  

I've used TurboTax Deluxe in past years, which I now understand only covers schedule C income, but not schedule C deductions.  I've upgraded to TT self-employed, hopefully this will allow me to do what I need to do do claim these deductions.  They're kind of a lot, including my mortgage interest maybe 10 or 15k more than the standard deduction!

Thanks for your answer, I do appreciate you helping out!

[Opus 17]

Your mortgage interest, property taxes, charity donations and state income taxes are deducted on schedule A, not schedule C.

You need to review your past tax returns.  You might want professional help.  You might also want to amend for additional refunds, in which case you need to do that by April 15, 2019 to amend for 2015.  (For 2016 and 2017 the deadline is next year.)

This is what is supposed to happen:  You report your gross self-employment income on schedule C, along with ordinary and necessary business expenses.  This calculates a net income (profit). Your net income flows to schedule SE for self-employment tax (about 15% of self-employment income).  The net income from business also flows to form 1040 where it is combined with other income such as wages and investments, then your personal deductions and credits are taken into account, and your income tax is determined.  Your income tax and self-employment tax are added together and that is your final tax due.  If you paid more into the system from withholding and extra payments than you owe, you get a refund.  If you under-paid, you owe a final payment.

The expenses from your W-2 job are entered on form 2106 (for tax years 2017 and earlier) and that goes to schedule A subject to the 2% rule; your expenses for the self-employment goes on schedule C and is not limited.


Now, let me describe two possible scenarios of how you might have reported your side income.

If you reported it as "Other income" or hobby income, it would go on line 21 of form 1040.  You do not have a schedule C.  You deducted your expenses on form 2106.  This is incorrect, because you did not pay the self-employment tax.  By not paying SE tax, you are cheating on your taxes, and you are also depriving yourself of retirement and disability credits in the social security system.  You might not get caught, but the IRS has 6 years to audit you.  If you amend and pay up, you will owe late payment penalties and interest, although you can apply for a waiver of the penalties.  

If you reported it as self-employment income and you do have a schedule C, but you only deducted expenses on form 2106 and not schedule C, then you over-paid your self-employment taxes.  Deducting expenses on schedule C reduces both your income subject to income tax and also your income subject to SE tax.  If you did not allocate your expenses between form 2106 and schedule C, then you probably overpaid your SE tax.  Taking some expenses off form 2106 will increase your W-2 taxable income but will decrease both your schedule C taxable income and your SE income, so a net positive gain for you.  You can amend back to 2015 if you get it in by April 15, and assuming you still have records that can determine which expenses were allocated to which jobs.

And as I mentioned before, if you and your spouse both do side gigs, you need separate Schedule Cs in each of your names.  If you work together and get one check, split it and split your expenses.  You need to be keeping really good records of course.

[gdgross]

Opus, really appreciate your detailed and thoughtful response.

It looks like we reported the expenses on the 2106 form, so we probably overpaid.  I don't think I'm going to hassle with amending the past returns, though.  

Since I purchased TT small business, I was able to add all of those expenses and assets back in the schedule C, and seems like we are more or less where we were in previous years.  

Thanks again,
Geoff