Is anyone aware of a good reference book for business models
specifically related to a small fabrication shop? I am not making
sales at this point, but I don’t think just reporting it as income
is going to work for me given my “day job” would throw everything
into a higher tax bracket. My primary concerns are limitation of
liability and tax efficiency. And how does one deal with end of year
inventory? If I am sitting on 10 pieces with a pot= ential sales
value of say $500 each, but with a fabrication cost of $100 each…
is my end of year inventory 50K or 10K? Can I just incorporate, pay
myself a small wage… and pay business taxes. I really am trying to
find some balance between simplicity and tax efficiency. I’d rather
not get too bogged down with the business end of this if that is
possible. Yeah, I know… it is a business. I do realize I need to
consult with a small business accountant… just want to educate
myself before taking that step.
The following are answers to the basic questions you asked, but are
likely to raise more questions. If so, and you are in the US, Google
SBDC (Small Business Development Center), find a local office and
phone them for a free appointment. SBDC’s are funded by the SBA
(Small Business Administration) and are charged with helping startup
businesses. Their basic services are free. The answers to your
questions are:
Taxes are generally computed on EBIT, whether you are incorporated
or unincorporated. EBIT is computed as:
Beginning Inventory
- Purchases
- Ending Inventory
= Cost of goods Sold (COGS)
Sales
- COGS
- Sales, General, Administrative costs
= Earnings before income taxes (EBIT)
As far as choosing incorporation or not, most people make the choice
based on (1) limiting liability and (2)tax effect.
LIABILITY DECISION
1a. Limited liability: LLP, LLC, Corporation
1b. Individual assumption of liability: Unincorporated business
TAX DECISION 2a. Taxed based on corporate rates: Corporation (no
S-election by IRS) referred to by IRS as C-Corp (any excess earnings
paid to the owner in the form of dividends are subject to double
taxation) 2b. Taxed based on personal tax return: LLP, LLC,
Corporation (S-election with IRS), Unincorporated (any dividends
from the corporations, paid to the owner are NOT subject to double
taxation).
Most small businesses choose: 1a and 2b, which means they will
choose to be an LLC, LLP, or S-Corp.
... but I don't think just reporting it as income is going to work for me given my "day job" would throw everything into a higher tax bracket...
Yup, reporting my extra sales as income doesn’t work for me either,
but I do it because it’s better than Federal Prison. It’s hell
making money 
Remember, only the incremental increase in your income (your jewelry
profits, not jewelry sales) can kick you into a higher tax bracket.
Your other income (day job) will still be taxed at the same level.
The alternative is to sell your jewelry at cost, then there’s no
profit to be taxed ;-).
Goodluck in your new venture.
Jamie
My primary concerns are limitation of liability and tax efficiency.
If you are trying to decide between an LLC or incorporating, the
liability is equal.
If you are sued you may have to prove that you actually treat the
shop as a separate entity from yourself. If sued, and your shop is a
corporation, the court may ask to see the minutes of your board of
director’s meetings. Minutes are simple to create, but if you
indicate that you don’t have meetings, the judge may decide that you
are really a sole proprietor hiding behind the corporate veil, and
you could ultimately be held personally accountable in the lawsuit,
even if your business is incorporated.
Tax preparation is more expensive and complicated for a corporation.
The tax advantage of a corporation is the ability to spread a loss
over a number of years to offset income in profitable years.
Compared to an LLC, the total tax paid for your personal income tax
plus the corporate tax will be greater if you form a C corporation;
but an S-corporation is not much better because the shop’s profit
will flow to your personal income tax return.
The most simple form of business is the LLC, which can be reported
on your personal income tax return.
I wonder if I would be able to use my metal work skills in federal
prison making auto tags? I might be able to convince them of
starting a designer line of tags for the discriminating driver…
LOL.
It just seems to me that after the gallery takes their cut (if you
are selling that way), and then Uncle Sam is waiting for his too…
not much is left. Guess one has to take that into account in
pricing.
If you are making your jewelry one at a time you are building your
customer or client base the same way, one at a time.
Enlightenment can be a big factor on both sides of the transaction
the person producing the jewelry/art and the person purchasing the
jewelry/art.
try to keep in mind that people who are our intended patrons are
overwhelmed with a practically infinite supply of products that have
the appearance of being " special". I have chosen the words
"appearance of being special" because to someone who has not had
craftsman training and been involved in seeing a job through to
perfection does not have as specific a benchmark to judge the
difference between mass mfg. product as a craftsperson/artist
producing a piece of work.
What am i saying here? try to seek out those people who are concerned
with supporting sustainable living practices, it could be any one
from community leaders & lawyers to school teachers and bar tenders.
ie, A person who supports a small scale local grower of food may be
philosophically prepared to understand what you as a metalsmith are
attempting to achieve.
put on a smile along the way learn to define the specifics of the
difference to those willing to listen to you explain that what you
do CANNOT be purchased at big box super retailer for less and then
hope for the best. you are building your customers and your jewelry
one at a time. as far as everyone getting a cut galleries and taxes
well… if you putup the money for a retail space then you can
solicit people to display thier work in your gallery and get paid if
something sells 
goo
Hey Brent…
Guess one has to take that into account in pricing.
You should take that into consideration!! AND… Most galleries do a
1099…I think thats the right number. I forgot to report one of
these long ago… about 6 months later the IRS wanted $500+.00,
can’t remember the exact figure. By the time I paid this penalty and
the gallery, making & selling that ring only made me lose $300+.00.
Taht was a good deal!
I now always add about 30% to anything I sell through a gallery.
Good Luck. Dan.
http://www.dearmondtool.com
I am sure that others will have jewelry specific answers, but from a
general small business standpoint, I would refer you to the NoLo
Press books. They have books to answer the general questions, forms,
etc. Just about everything that you will need to help you decide
what business model, and the forms to implement the model. Good Luck
on the future venture.
John.
I don't think just reporting it as income is going to work for me given my "day job" would throw everything into a higher tax bracket.
If you want to conduct ‘business’ without overly increasing your tax
liability (because of the job) remember that a ‘company’ pays tax
based on profit, not sales (beyond certain minimum tax). Just make
sure you are not profitable (I can’t believe I just said that). Make
your expenses equal to or greater than sales. Figure that one out.
Just make sure you are not profitable (I can't believe I just said that). Make your expenses equal to or greater than sales. Figure that one out.
Be careful with this idea. I am by NO means any kind of authority on
taxes, but I’m pretty sure I knew someone who did this, and the IRS
ruled that if they never made a profit, it was a hobby not a business
and disallowed all their business deductions.
Noel
Be careful with this idea. I am by NO means any kind of authority on taxes, but I'm pretty sure I knew someone who did this, and the IRS ruled that if they never made a profit, it was a hobby not a business and disallowed all their business deductions.
I haven’t checked the IRS tax laws lately, but I believe Noel is
right. If you run a small home based business, you should show a
profit (even if it’s a small one) at least once every 5 years.
Dave
If you want to conduct 'business' without overly increasing your tax liability (because of the job) remember that a 'company' pays tax based on profit, not sales (beyond certain minimum tax). Just make sure you are not profitable (I can't believe I just said that). Make your expenses equal to or greater than sales. Figure that one out.
I got started by reading “The Idiots Guide To Starting A Business.”,
available in most large bookstores. You need to read it, and fast!
In the meantime, there are three things you need to consider, if you
are living in the United States:
-
The most common arrangement for running your own business on the
side of a day job is “sole proprietor”. Report your wages as usual
on your Form 1040. Use Schedule C to list your sales versus your
legitimate business expenses: raw materials, energy, tools, studio
rental, etc. Schedule C will calculate your profit and then assess
your FICA, Unemployment, and Medicare taxes. You plug these figures
back into your Form 1040. -
State sales taxes. Before you begin your business you need to
obtain what most states call a Transaction Privilege and Use Tax
identification number, more informally known as a business license.
Since you are operating as a “sole proprietor” you will most likely
not need a separate tax id number, your own social security should be
adequate for the license forms. You then remit all taxes you collect,
with a monthly form, to your state tax office. -
State income tax. Fairly simple. Most states use your Adjusted
Gross Income as a starting point, a figure that is derived from both
your wages and profits.
The gentleman who says that you should run your business at a
constant loss is incorrect. The IRS requires that you be running your
business in the black for at least 4 to 5 out of every 7 years or
more, depending on the nature of your business. If you fail that test
your business expenses will be disallowed because your activity will
then be considered as a hobby.
There are two major drawbacks IMHO to running as a sole proprietor:
-
Business liability. While a good idea to have $1M business
liability insurance in any case this can quickly become exhausted in
egregious cases. As a sole proprietor you have no legal shielding
against a plaintiff going against your personal assets if your
business liability insurance is insufficient against a legal
judgement. This is nowhere near as dire as it sounds since this does
not happen often to small time operators… but if you are concerned
you should consider becoming a Limited Liability Corporation. -
You cannot pass a business loss based on being unprofitable onto
your 1040 based on Schedule C. You CAN claim certain special losses
such as theft, casualty, etc, as itemized deductions on your 1040,
however.
Be careful with this idea.
Absolutely! There are restrictions and criteria that you have to
work within. But there are also businesses that run years w/o a
profit.
http://www.irs.gov/newsroom/article/0,,id=169490,00.html
From that page I would conclude that you need to be a C Corp to be
OK. Certainly always check with your tax advisor as there are other
important considerations.
Noel,
and the IRS ruled that if they never made a profit, it was a hobby not a business and disallowed all their business deductions.
Close. If you never make a profit, the IRS can and will rule that
you business is a hobby. They will allow you to deduct your “hobby”
expenses only against your “hobby” income. Thus you won’t have to
pay income taxes on your “hobby” sales. However, they won’t allow
you to offset your “hobby” loss against other types of income when
you have more hobby expenses than sales.
Regards,
Jamie
(CPA in a earlier life, so take my advice with a grain of salt)
Close. If you never make a profit, the IRS can and will rule that you business is a hobby. They will allow you to deduct your "hobby" expenses only against your "hobby" income. Thus you won't have to pay income taxes on your "hobby" sales. However, they won't allow you to offset your "hobby" loss against other types of income when you have more hobby expenses than sales.
I may be way off on this, but my understanding is that when you have
a business, and have a net loss, you can deduct the loss against your
other personal income…but you may not do so after five years of
loss.
And I have a question: if you can’t deduct your ‘hobby’ expenses
against your ‘hobby’ income, are you taxed on your hobby income? I
don’t think so, so really it’s a wash.
And one more item, put out there for someone who may know for
sure…I am under the impression that if a person declares part of
his/her home as ‘home office’ - say 10% - and then goes to sell the
house, 10% of the sale is not allowed in the rollover to a new
house…and if there is a profit made (hardly in these times, but
still) the 10% comes under capital gains. Anyone know anything about
this? I knew I would be selling my loft in NY and was advised not to
take the home office deduction the year before I sold.
The gentleman who says that you should run your business at a constant loss is incorrect. The IRS requires that you be running your business in the black for at least 4 to 5 out of every 7 years or more, depending on the nature of your business. If you fail that test your business expenses will be disallowed because your activity will then be considered as a hobby.
I did not say show a net operating loss ‘in perpetuity’. Corps have
different rules. I don’t believe there is this 3 out of 5 "hobby’
bit (and that is not the sole test). A Corp can carry a NOL(net
operating loss) forward for up to twenty years to offset profits in
good years. First year in biz is usually a loss. Loss, bingo, no corp
tax. When a Corp starts showing net profit, those previous losses can
reduce new taxes on the now profitable biz. Also, Corp owners’
salaries are deductible as business expense, the individual still has
to pay regular income tax on his salary of course. One can choose
what is salary and what is dividend but there are rules about that
so check it out first. But if one structures it right one can perhaps
avoid the impact of being shoved into a higher tax bracket. Now, if
one used their personal funds to start the company or keep it afloat
those funds can be counted as a loan from officers. Hence the payback
of those funds become deductible expenses to the corp and tax exempt
to the individual(as they are not really ‘income’). And that beats a
poke in the eye with a sharp stick every time.
Example (these are quite random numbers) One makes a certain salary
on their ‘day job’ that is say, $10,000 below the next tax bracket
jump. After the payback of the loan is complete, one could pay
oneself a ‘night job’ salary slightly less than the $10K which would
keep one in the same bracket. One still has to pay income tax on the
ten grand but its at the lower bracket rate. “Excess funds” could be
spent on legitimate business expenses needed to build said business.
Drooling for tools? This strategy could take you several years into
the business.
I suggested this as a way of transitioning from hobbyist to
professional, which was my understanding of the OP’s predicament. It
requires incorporating and actually BEING a business. One could
select which form of corp is most beneficial at the time, with the
knowledge that the biz could restructure itself into another form at
a later date, depending on circumstances.
The law allows you to use every legitimate tool to reduce tax. Don’t
be reckless though. And I should say there are certain additional
expenses and criteria in becoming a Corp so play with the numbers
before you jump in.
make the expenses match or excede your business revenue
Not a good idea!
IRS will Rule it a hobby (after a number of years) and disallowed
the last 7 years of business loss deductions and you have to pay
taxes on the revenue.
I knew someone who did this with boarding horses on their farm. They
ended up owing close to $40,000 in taxes. Actually subdivide there
property to pay the taxes, buts that’s another ridiculous story in
itself.
Not sure about IRS rules but while in Canada a decade+ ago I paid my
tax guy an awful lot of money to write off my home business losses
against my day job. The tax man bitched about other small details
every few years but in the end I came out far ahead. Serious stuff
was never questioned.
My tax guy was an amazing crook, I learned a lot going through 5
years of past tax forms which I probably I shouldn’t know. I am
pretty honest these days but the temptation and knowledge is still
there 
jeffD
Demand Designs
Analog/Digital Modelling & Goldsmithing
http://www.gmavt.net/~jdemand
It isn’t so much that you are required to show a profit x out of y
years, as it is whether you are running a legitimate business. Many
start-ups show losses for several years. The IRS looks closely at
businesses that are composed of activities that are often pursued as
hobbies, such as jewelry-making, because they don’t want people
deducting losses from what is really a hobby. The theory is that if
you were seriously running a business, you couldn’t afford to keep
losing money.
The facts and circumstances surrounding each case determine the
likelihood of prevailing upon audit. The more you look like a real
business, the better your chances. For example, if you sell your
jewelry to your friends and coworkers, but never collect or remit
sales tax, that would work against the claim that you are a
legitimate business.
As far as hobby losses, you can generally claim them up to the
amount of your hobby income.
Regarding becoming a corporation, that is a viable idea, but I
suggest consulting a CPA before deciding on a choice of entity.
Different types are right for different people.
Disclaimer: I am a CPA.