Ep 151 – Brass TAX, Especially for the Esthetics Industry

 

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0:00:56.6 Ella Cressman: Hello and welcome to ASCP Esty Talk. I am Ella Cressman, licensed esthetician, certified organic skin care formulator, and content contributor for Associated Skin Care Professionals. 

 

0:01:07.0 Maggie Staszcuk: And I am Maggie Staszcuk, licensed esthetician, and ASCP's cosmetology education manager. 

 

0:01:13.1 EC: Maggie, we have a kind of a big shout out today. 

 

0:01:16.9 MS: Oh, I'm excited. 

 

0:01:18.2 EC: Yes, today we're gonna shout out all the small esthetic business owners, both the solo practitioners and those who have grown their practices to whatever size. You know what it means to be a one-man band, wearing many hats and not only providing services, but also social media management, bookkeeping, record keeping, marketing and sometimes even security. [laughter] You listen to our whoops-a-doosies, and you do it all while juggling new clients and maintaining client retention. We see you and we are proud of you, and today's episode is for you. We are super excited to have a guest in the studio today. Welcome Kevin Leary, managing partner of Newton & Associates, a CPA firm here in Golden Colorado. Hi, Kevin. 

 

0:02:00.9 Kevin Leary: Hi. Hello, thank you for having me today. 

 

0:02:01.7 MS: Happy to have you. Before we get into more specific questions, we do wanna state the content in this podcast is for informational purpose only, and is not intended to provide and should not be relied on for tax, legal, or accounting advice. You should consult with your own tax, legal and accounting advisors before engaging in any transaction. 

 

0:02:21.0 EC: You know, I think it's always interesting to find out what made people get into their profession. So, Kevin, what made you get into accounting and specifically tax preparation?  

 

0:02:31.1 KL: Sure. Around 2008, I had been working in politics and working in restaurants outside of campaign season, and you may recognize that as the year that the subprime collapse happened and there was the meltdown of mortgage-backed securities. And I was kind of thinking about a career change because politics was not fun at all. [laughter] So a few people in my family were accountants and I had spoken with them, and really accounting is sort of a recession-proof industry, and that was very popular back around 2008, 'cause a lot of people in the mortgage market... Or excuse me, in the mortgage industry, were looking for jobs. So that was what... Or that was the impetus for me to go back to school, get my accounting education, and it was a personal story that led me into the tax world. My uncle passed away in 2008 unexpectedly and left an estate, and my dad actually went to go meet with our accountant, Joe Brown, before the 2012 filing season. 

 

0:03:41.3 KL: And Joe kinda asked, "What's Kevin up to right now?" And I was sort of in-between jobs, I had been doing accounting and payroll for a couple of different companies, and the tax office that I started at needed help inputting tax returns, so I started off for $12 an hour putting W-2s, and interest statements, and mortgage interest, and charitable giving, things like that into the computer for others to review. So that was how I ended up getting into tax, and that was where I began. 

 

0:04:11.7 MS: I think that's cool because then you have, like, the base knowledge to build from. I think that's an awesome story. 

 

0:04:17.6 EC: Kevin, there seems to be a prominent gray line between independent contractors and employees, and what would you say is the difference as far as the IRS is concerned?  

 

0:04:29.7 KL: Sure, and a lot of times what you... It's not really the IRS that you have to be concerned with. It's the State Labor Department. In fact, Ella and I just went through a labor audit on her corporation. So, classification of workers, whether employees or independent contractors, it's just as important at the state level as it is at the IRS level. In fact, it's a lot more important at the state level, because the state is far more aggressive in auditing that particular relationship, and that's because they have the most to lose. 

 

0:05:03.2 KL: So what I usually tell new business owners when they sit down with me, you know, most of them will read on the internet that independent contractors are better from a tax standpoint. You know, and the simple idea there is the independent contractor is responsible for all of their own taxes, not their... Not payroll taxes like you would be paying for an employee and not state unemployment insurance, which is something that you have to pay on employees as well. When I sit down with new business owners, the first thing I tell them is influence and control are the biggest defining characteristic of that relationship. If you tell someone when to show up, where to sit, what to do, when to go home, you give them tools and training to do their job, that person is going to be considered an employee. You know, if you think about Ella's business, for instance, Ella also does some bookkeeping accounting on the side, and she's very good at that. I don't know that she's looking for additional clients or additional work. 

 

0:06:06.2 MS: [laughter] No, I'm, I'm busy right now, but I'll keep everyone posted. [laughter] 

 

0:06:09.0 KL: But if I were to enlist Ella's help for accounting, she already has the tools, she has the software, she has the knowledge and the training to get the job done without me directing her on how to get it done. Also as a business owner, she's maintaining all of these different tasks and liabilities that she has, so I'm not telling her I need project A done by the end of the day. I tell her I need project A done, and it's up to her to get it done based on the contract that we've set. So that's the primary difference between an employee and an independent contractor, and that's where labor will nail you if you don't have your ducks in a row. 

 

0:06:52.8 KL: If the independent contractor operates their own business, if you are the only person that they are an independent contractor for, that smells and looks a lot like an employee, whereas going back to Ella's business, she clearly has many clients on the esthetician side as well as the accounting and bookkeeping side, so that is evidence that she has an ongoing business instead of a misclassified employee-employer relationship. So that's what you have to be careful about when you are trying to figure out what's the best fit for your business. 

 

0:07:32.4 EC: Sure, so you often have people working at a spot that are 1099, but they do not have, say, an LLC, and still this place of business is telling that individual all the things you just said, when to show up, what they are required to do, what hours they have to work. And so the lines do really get blurred, and from the esthetician standpoint, how do they handle that with the "employer?" 

 

0:08:03.3 KL: The way to protect yourself in a labor audit, 'cause that's really where the rubber meets the road here, is anyone who works for you as an independent contractor generally should have their own business set up, an entity of some type, usually an LLC or a corporation. Also, businesses generally carry insurance. This is especially huge for not necessarily estheticians but roofers, re-modelers, et cetera, like Ella's dad who I also work with as well. So that is super important to remember that the more that the individual's activity that they do with you looks like a business with labor, the more evidence they have that that person is engaged in ongoing business. 

 

0:08:51.0 EC: The more independent they are then they really are an independent contractor therefore 1099, right?  

 

0:08:56.1 KL: Correct, and so you see a lot of mis-classified employees basically, because it's easier to treat them as independent contractors, so that's what I see, but the way that you want to protect yourself, to some extent as the esthetician who's contracting with these independent contractors, make sure that the people you work with have their own LLC and their own insurance liability, or their own insurance certificate, whether for liability, workman's comp, whatever that looks like. Beyond that, they look at things like, do you have a business card? Do you have a website? Do you advertise in any way, shape or form, do you do this type of work for anyone else, or is it strictly with the esthetician in this example, those are the types of things you should be aware of when you are differentiating between the workers that you have whether they're employees or independent contractors. 

 

0:09:51.0 EC: I think that's why it's fun, that's why we wanted to do this podcast because we see a lot online of estheticians, I do, in particular, "I got this job offer, it's this person, I'll be a contractor, is this a good deal?" Or "I'm working as an independent contractor, but I have to stay from 10:00 to 6:00. And there's down time and I'm not getting paid." And so this is hopefully gonna clarify, as Kevin said, make sure to check with your state labor board, but this will hopefully clarify so that that doesn't happen. 

 

0:10:21.6 KL: I always think it's helpful when you're having this conversation to differentiate between the legal structure of the entity and the tax structure, or the tax classification of the entity, so the legal structure of an entity, which is how I more generally refer to a business, the more common forms that you see around here are LLC, limited liability company, or a corporation. You file Articles of Organization to organize an LLC, you file Articles of Incorporation to organize a corporation. Your accountant can help you with this. A lot of people who have experience doing this in the past find it's not very difficult at all, it's very inexpensive in Colorado, which incentivizes new business growth, but that's really the legal classification of the business because since Ella brought up her own business, she had a single member LLC, which by default is a disregarded entity for tax purposes. 

 

0:11:27.8 KL: So what does that mean? That means that while Ella was operating as an LLC, her business functioned like a sole proprietorship, a sole proprietorship, which is a tax classification, not a legal classification, is the type of business that you organize when in essence, you just put your sign out in front of your house or your space and you start working. If you have an LLC, while you have a legal structure, for tax purposes, everything passes through to the individual taxpayer, just like a sole proprietorship. You can elect to have that LLC be taxed differently. Generally speaking, that is going to be an S corporation. 

 

0:12:11.1 KL: You're not going to find many accountants who will recommend a partnership, I would imagine, unless it was a more complex structure, and a C Corporation is an entity type that is really now reserved for large companies, there are clearly some that still exist that were formed a very long time ago that are small businesses, but you don't really see any new creation of C corporations as a tax classification. So just real briefly, 'cause I really don't wanna bore everyone to death, an S corporation is a pass-through entity, meaning that all of the income is taxed at the individual level, that is beneficial for a small business owner, 'cause they don't have to deal with the double taxation in a C corporation, and they don't have to deal with the very high self-employment tax of operating as a sole proprietor. 

 

0:13:07.5 MS: You're saying operating like a sole proprietor, we're just talking in terms of taxes, because if there is a claim, your personal assets are still separate from the business, correct?  

 

0:13:16.9 KL: So I don't get into that because I'm not an attorney. 

 

0:13:21.1 MS: Sure. Okay. 

 

0:13:21.4 KL: Okay? But here's what I know. My clients who go consult with an attorney about their business structure, always come back with either a corporation or LLC, a nice big shiny LLC or corporation organized by the attorney. To what extent that limits your liability on your personal assets, if something goes wrong, that is a case-by-case situation, and I would just say that a buddy of mine was a developer a long time ago, had multiple LLCs that were operating all these different development projects, and when one of them went bad, he was sued at the LLC level and individually. So I can't speak to whether or not there's really asset protection there from a legal standpoint, but that's generally the concept, is that you're separating the operations of your business from your personal assets from a liability standpoint. 

 

0:14:17.0 EC: Hold that thought. We'll be right back. 

 

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0:15:05.2 EC: Okay, here we go. Let's get back to the podcast. 

 

0:15:08.1 MS: In recent years, there have been some changes. In 2020 specifically, there were stimulus payments, PPP payments, not to mention the regular annual changes in tax law. What are some of the most surprising tax law changes you have witnessed?  

 

0:15:23.3 KL: One of the main changes that really simplified taxes at the individual level was increasing the standard deduction, and this was part of the Trump tax bill. Where it's relevant to our audience perhaps today, is that you're no longer allowed to deduct un-reimbursed employee expenses. So it used to be that if I was an employee of corporation X and I was incurring expense for the benefit of the corporation, but I was not being reimbursed, I got to deduct that on my taxes. So that was a big deal if you were employed, not only as an esthetician, but really anyone at all. So that changed the paradigm between self-employed people and employed people in terms of their ability to deduct things from their income. That was an interesting change simply because there was a lot of aggressive behavior on the 2106, which is where you used to put those expenses, right?  

 

0:16:24.3 KL: One of the more interesting things that's happened in recent years, and it was a part of that same Trump tax bill, is the qualified business income deduction; a lot of times, without getting into the weeds, self-employed people can have a higher tax burden than an employed person, especially when you look at self-employment tax. So the qualified business income deduction, which generally speaking, gives you a deduction of 20% of your net profit. So if you make $100,000, it's a $20,000 deduction generally speaking. That leveled the playing field between employed and self-employed people and brought more parity between the two, which I always find interesting, 'cause there is some effort by policy makers to achieve parity between the two. That's one of the reasons that adjusted gross income is used as a threshold for a variety of things, because they have attempted through that process to make it a similar situation for employed and self-employed people. It was a big deal for self-employed people because it cut their tax in a significant way. That is one of the reasons I find it to be so interesting. 

 

0:17:31.2 MS: So standard deduction versus writing off individual things. 

 

0:17:36.2 KL: Yeah. Generally speaking, your itemized deductions are state and local taxes. You may have heard a lot about this with cap on SALT deductions, that's State and Local Taxes, that's SALT. Mortgage interest is what I call the triggering deduction because a lot of times, it's the number on the return that gets you close enough to itemizing that now everything else makes sense. Charitable giving is also on there as well as deductible medical expenses, things like that. So that's, generally speaking, the difference between itemizing and taking standard deduction. With the Trump tax bill, most taxpayers take a standard deduction, and I think it's something like 86% take standard deduction. And that has nothing to do with your business deductions, and there's so much confusion with taxpayers on this. Itemized deductions are personal expenses that you are allowed to deduct from your total income. Business expenses are items that you're allowed to deduct directly from your gross income of your business. They are not the same. They are two completely separate items, and I see a lot of confusion with taxpayers where they co-mingle those together. 

 

0:18:44.5 MS: What are some other common mistakes that you see small business owners make? Like filing for themselves or not taking deductions and taking too many deductions. 

 

0:18:53.3 KL: Sure. Starting up your own self-employed business is relatively speaking very easy. And so what I usually see taxpayers do wrong, I suppose, is that they get stung by a giant self-employment tax bill before they come in and have us change the structure of their business. Although it makes the change that I make seem much more palatable than if you don't have that experience where you just get absolutely crushed on self-employment taxes on your 1040. But I see quite a few other things. I see a lot of deducting liability payments when you're paying off a thing like a vehicle or a piece of equipment, and you can get sideways with the IRS there, 'cause you're really not allowed to deduct those payments, you recover your cost in those assets in a different way, but the main thing that taxpayers do, which is something I don't quite understand, is this pursuit to spend money to save money, if your tax rate is 30%, you should not be out spending money at the end of the year that you do not need to save money on taxes. 

 

0:20:04.4 KL: If you just take Ella, for example, if she's got an extra $10,000 laying around in her business at the end of the year, and I tell her, "Hey, your marginal tax rate is 30% on that, so you're gonna end up paying $3000 in tax." If you go buy a $10,000 piece of equipment that you don't need, you now have $3000 in something you don't need, whereas if you had just held on to the money you have $7000, 'cause you paid your $3000 in tax on it. It's far better to hold on to the money and pay the tax generally, and that's something I see self-employed people doing all the time, bending over backwards trying to find ways to spend money to save money. It's a bad deal. 

 

0:20:42.8 EC: I think that's an old school thought, because when I was... I mean, I have a business degree, I have to shout Kevin out here a little bit, I have a business degree, I get a lot of this stuff. I worked in accounting before I became an esthetician and I still call Kevin a few times in tears, like "I don't understand what's happening right now," because I mean, I've been to the ringer, we've had IRS audits, we've had unemployment audits, state audits, and I'm very well-versed at this point. But I remember working in industrial construction, which was not small business, this is a big business, early 2000s and not something that we did. We would up our fleet, for example, we would add different software, and so if we look at that compared to the aesthetic business, that's when perhaps maybe some of those old school philosophies come in, or old school advice comes in, it's like, "Get this piece of equipment," or "Make sure you have different supplies," but those assets are taxable, too. 

 

0:21:40.1 KL: Yeah, and really tax rates are, historically speaking, very low right now, if you rewind to the Reagan administration, some of those tax rates were very high, as high as 50%, 60%, 70% on income levels you wouldn't necessarily expect. So there is this conventional wisdom that you need to dump all your profit into inventory or equipment or whatever that might be at the end of the year, and I simply don't believe that that's as important now as it was in the past. 

 

0:22:11.8 KL: The other thing that I see quite a bit, and kinda going back to the Reagan tax rates, most of the people in this podcast appear to be about my age, which means all of our parents were earning money in the '80s, generally speaking. Kind of conventional wisdom, also is to defer money into your retirement. But the baby boomers, my parents generation, and I assume your parents generations as well, certainly yours, 'cause I know your dad, they were deferring their income sometimes at 50%, 60%, 70%, and today they are taking money out of retirement at 12%. So if you take an example of someone who deferred income at 50% in the '80s and is taking out at 12% today, even if they held that in cash and didn't invest it in stocks or things that appreciate over time, they've made a 38% margin on just deferring the income, 50% minus 12%, that's a 38% margin. 

 

0:23:13.3 KL: A lot of business owners I meet with today are trying to find ways to defer income at 12% federal and 5% state, 17% is tax you should be paying, so it doesn't mean you can't put money into retirement, it just means you should be looking at after tax options like a Roth IRA, as opposed to a traditional IRA, basically, because the bang for your buck of deferring income is not the same when income tax rates are so low. So, I like to tell business owners that right off the bat, because a lot of people learned the method that they run their business from watching their parents or friends of their parents or things like that. That's a mistake in my mind because it just doesn't work anymore. It's not like you shouldn't be putting anything into retirement, but you should be thinking a lot harder about whether or not you're deferring the income and paying the tax today or paying the tax down the road. 

 

0:24:09.9 EC: When it could be more. 

 

0:24:11.3 KL: When it will likely be more because our country has tons of debt. Just to put my economist hat on for a hot minute here, 'cause that was my first degree, that was what I wanted to do before I became an accountant. When you engage in as much deficit spending as we have, it is a de facto tax increase at some point, the game is to hope that you die before taxes go up, but it is likely that across the board, we'll have higher tax rates in the future because we have to pay that back at some point. 

 

0:24:41.4 EC: Well, Kevin, on that note, thank you so much for being with us today. I always love talking to you 'cause you have a way to break it down super simple, and I appreciate that very much, and we hope to have you back on another podcast soon. 

 

0:24:53.9 MS: The content of this podcast is for informational purposes only, and is not intended to provide and should not be relied on for tax, legal or accounting advice. You should consult your own tax legal and accounting advisor for engaging in any transaction. 

 

0:25:07.9 EC: Now, listeners, we really wanna hear from you, do you do your own taxes or do you delegate that to a professional? Be sure to comment on our social media platforms, especially Instagram and Facebook, or reach out via email at getconnected@ascpskincare.com. We wanna know all the details. In the meantime, thank you for listening to ASCP Esty Talk. 

 

0:25:28.4 EC: For more information on this episode or for ways to connect with Maggie or myself, or to learn more about ASCP, check out the show notes and stay tuned for the next episode of ASCP Esty Talk.