Tax Time for Beauticians: Your Guide as a Self-Employed Business Owner

Can you confidently say you are in complete compliance with the IRS and other tax collection agencies?

Studies have shown that only 1% of taxpayers are audited, while 2.5% of small businesses are at risk of an IRS audit (Weller, Chron). Many small businesses neglect to properly prepare federal and state returns and forms, making them a target for audits.

Governing bodies want to be sure that all income is accurate and deductions are valid for self-employed individuals.

Many nail and beauty salons fall under the category of self-employed, so be sure to follow these tips and strategies to ensure a smooth tax filing.

How Does the IRS Define a 1099 Employee?

Let’s first take a look at the difference between an employee and self-employed individual. The IRS sets out clear distinctions between the two since it changes the way individuals are taxed.

Three categories are examined: behavioral, financial and type of relationship (IRS). If you control your work schedule, financials, and benefits, you are most likely a self-employed individual.

On the other hand, if someone sets your work schedule, has complete control over the financials and gives you an employment contract, you are an employee. Understanding this difference will allow you to not only comply with tax laws, but also help you properly classify any individual that perform work for you.

Owners of beauty and nail salons are almost always classified as a self-employed taxpayer.

Understanding Your Filing Status

Under both current and past tax laws, self-employed individuals in the beauty industry who file taxes as a Sole Proprietor or Single-Member LLC report income on Schedule C of the 1040. This then subjects these individuals to self-employment taxes, but also gives way for eligible deductions.

On the other hand, businesses that are set up as a Partnership or Corporation still get to deduct eligible expenses, but they will file a business return.

The latest presidential reform safeguards small businesses that report income on the individual return from potential tax increases.

Utilizing the Qualified Business Income Deduction

One aspect that has stayed the same is the Qualified Business Income Deduction, commonly referred to as QBID. This allows business owners to deduct up to 20% of the pass-through business income as a deduction, directly reducing taxable income.

For example, if you make $100,000 in net income through your beauty salon, you could be eligible to deduct up to $20,000 off your taxable income.

C Corporations are not allowed to take this deduction and there are income limitations.

Many self-employed beauty professionals will qualify since they are not set up as a C Corporation and are below the income threshold but be sure to consult a professional on how to maximize this deduction.

Properly Handling Tips

Many salon self-employed individuals receive tips as a part of their compensation.

In recent years, the IRS has made more efforts to crack down on individuals who are not fully reporting tips. The IRS has even gone to the extent of conducting a year-long study on unreported tips to fully gauge the situation.

Keeping accurate records and fully reporting tips can seem like a tedious process, but it is completely necessary to avoid any unfavorable rulings by the IRS.

The penalties imposed for misreporting income are more significant than the tax you would pay on the reported tips. Additionally, many lenders look at gross income, which includes tips, when looking to loan you money, whether that be for a house or car.

You know the money you make, but lenders might not without valid proof on the returns.

Dealing With 1099s

Accurately distinguishing between a self-employed contractor and employee is critical because of the recent changes passed by the IRS.

Starting in 2020, all income paid to contractors over $600 needs to be reported on Form 1099-NEC that you will need to file as a business owner. Like anything, the penalties for neglecting to file are stiff and can significantly impact your beauty salon.

You will need to keep accurate records of all work performed by contractors to issue 1099s.

Moreover, there was another change enacted by President Biden on March 11, 2021 that alters the reporting guidelines for the 1099-K. Previously, third party credit card transaction companies only needed to issue you a 1099-K if you had more than 200 transactions or $20,000. The new law drops this number down to $600, meaning you will be receiving multiple 1099-Ks that need to be reported on the tax return.

The IRS can now easily check your tax return with the 1099-Ks issued to determine any underreported income, directly impacting your small business.

Breaking Down Deductions

Now that we’ve looked at a basic overview of items you should be aware of as a self-employed beauty salon, let’s dive into some common deductions to keep an eye out for.

Reporting your income accurately is only one piece of the puzzle. The other half is taking eligible deductions.

To be considered an eligible deduction according to the IRS, the deduction needs to be ordinary and necessary within the course of your business (IRS). Sunscreen for your Florida vacation would not qualify as a business expense but taking a client out to lunch would.

Common Deductions to Watch Out for:

• Rent: Money spent renting or leasing a facility to conduct your business is an eligible expense. Renting a chair in a larger salon would also be considered rent.

• Supplies: Any material or supply you purchase that is directly used in your business. For example, nail polish for your nail salon or a new blow dryer for your hair salon.

• Insurance: Professional and rental insurance can be deducted. Many small business owners are required to have some form of liability insurance.

• New Equipment: The rule of thumb is that anything over $2,500 gets capitalized and depreciated, while anything under this threshold can be immediately expensed. A business laptop or new salon chair would qualify as equipment.

• Advertising: Printing business cards, banners or any other form of advertising is an eligible business expense. Be sure the advertising is related to your business and not for any hobbies.

• Cleaning: Fees associated with cleaning your salon can be taken as a business deduction. Don’t forget cleaning supplies like detergent and wash cloth are all eligible items.

• Salaries & Benefits: When you’ve grown to the point where you are ready to add an employee on, these expenses are deductible. Be sure you are hiring an employee and not an independent contractor by following the rules stated above. Any payroll taxes are also deductible.

• Licenses: Many salon owners are required to have a license. The license and registration costs associated with your principal business activity are deductible. However, renewing your personal car license would not be an eligible expense.

Frequently Missed Deductions:

• Auto: Although this may be an uncommon business expense, auto expenses are deductible for qualifying travel. For example, driving an hour to the beauty store is a qualified deduction for mileage and gas.

• Travel: Traveling to a beauty convention or seminar gives way to a deduction. The airfare, lodging and transportation associated with the trip are fully deductible.

• Meals: Meals with clients and employees are 100% deductible at certain restaurants for 2021 and 2022. After 2022, the limit drops back down to 50%, so be sure to take advantage of this deduction.

• Phone: A business phone or a personal phone for business qualifies as a deduction.

• Home Office: Maybe you run your business out of a room in your house. Well, be sure you take the home office deduction so you can deduct a portion of the mortgage interest, utilities, and property taxes on the return.

Wrapping it All Up

This all may seem like information overload, but it is best you fully understand your business in order to stay in compliance with governing bodies. Running a business as a self-employed individual is more than just pleasing your clients; it’s managing everything effectively behind the scenes as well.

Here are some final words of advice: invest in a software, keep all your receipts, and build a relationship with a professional. You don’t have to go through this journey alone.

Sources

IRS. “Independent Contractor (Self-Employed) or Employee?” IRS, 9 November 2021, https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee. Accessed 30 November 2021.

Weller, Emily. “Top-10 IRS Audit Triggers.” Chron, 2021, https://smallbusiness.chron.com/issues-happen-there-many-expenses-being-allocated-businesses-23631.html. Accessed 30 November 2021.