Side Business loss with W2 Income
By Tim Frye
Any tax preparer worth their salt knows that deductions are the bread and butter of this business. They reduce taxable income, they can keep you in lower tax brackets when your gross income is high, and can reduce your tax liability greatly. As a tax preparer, it is obviously to your benefit to completely understand the value of deductions and be able to apply them appropriately to your clients specific situation. Schedule C loss, or business loss, can provide a potent deduction for your client, especially when they are still working full time as an employee. This article will get in to the benefits of reporting a Schedule C loss with a side business while still reporting full time employee wages.
Adjustment to Income
Let us first go into the details of the how deductions and adjustments differ. Essentially, they both accomplish the same feat, which is the reduction of gross income before it is taxed. However, an adjustment is considered to be an “Above the line deduction.” This means is that an adjustment is applied against gross income prior to the line. The line is reserved for the demarcation of Adjusted Gross Income. An above the line deduction is extremely valuable because of the fact that it can lower AGI, and AGI is the number by which many of the floors and ceilings of deductions and credits are judged, and by which many of the phase ins and outs are implemented.
Additional Deduction to Income
It is generally assumed by the IRS that the first couple years starting a business can be rather difficult and losses will be incurred. If your client is a full time employee and has started a business on the side, and shows a loss, there is definitely a benefit. Normally, a taxpayer is limited in terms of their decisions on deductions. They are forced to claim the standard deduction, or, if they have qualifying expenses exceeding the standard designation, they can itemized deductions using the Schedule A. The business income loss essentially allows for an extra deduction on top of either the standard deduction or itemized deduction, which can provide an extra punch against gross income before it is to be taxed. So let’s say your client takes a $10,000 business loss for the tax year, and their marginal tax rate is 25%. The loss will save them $2,5000 dollar for dollar, and that is before they have levied their standard or itemized deductions against Adjusted Gross Income.
2% Miscellaneous Work Expense Floor
Another benefit of using the Schedule C is when your client is listing their unreimbursed work expenses. When a taxpayer has the opportunity to itemize their deductions, there is portion of the Schedule A that is reserved for the reporting of miscellaneous unreimbursed work expenses. The catch with this is the work expenses will not even begin to register and be subtracted from taxable income until they exceed 2% of the taxpayer’s Adjusted Gross Income. So if your client’s AGI tops out at $30,000, his work expenses will not even begin to count until the exceed the floor of $600. With a Schedule C there is no such restriction on work expenses. The taxpayer receives the full deduction against their self-employment income, which can in turn create a loss that will be applied against overall gross income.
The art of applying deductions must be mastered if you expect to be an outstanding tax preparer. It is often not as easy as it seems. You must be able to precisely direct the proper deductions specific to your client, and specific to their current and future situations. This is not rocket science, but it is also surely not a walk in the park. The true master will find that it is a niche somewhere in between, and if you perfect the art of deduction application, you can expect to be sitting on a chunky wallet for the remainder of your days above ground.