How Do Independent Contractor Taxes Work?

November 14, 2014 : Mike Slack

Editor’s Note: Do you work at home as an independent distributor for a multilevel marketing company? If you do, you probably understood that sentence. If you’re thinking of being a direct seller of some of your favorite products – then we have some information about the potential tax implications for you.

Today it is not uncommon to become an independent distributer by selling goods on behalf of a company as a means of generating extra cash. As of 2013, there was an estimated 16.8 million Americans taking part in this line of work, generally referred to as direct selling. Mary Kay, Amway, Scentsy and Herbalife, to name a few, are a few well-known companies that provide these opportunities.

While discounts on products are one benefit to becoming a direct seller, the thought of earning extra cash is also attractive. However, every year we hear from clients who are surprised to learn that they still have to file a Schedule C, even though they made only a small amount of money through these efforts.

Self-Employment Tax

The truth is that the tax laws apply to direct sellers in the same manner as other taxpayers. This generally means that the income and expenses of the for-profit business activity are reported on Schedule C as self-employment income. As self-employment income, any net profit from the activity is subject to the 15.3% self-employment tax, which functions in a similar manner as social security and Medicare taxes employees would have withheld from their wages.

Home Office Deductions

If you use your residence for business purposes related to your direct selling, you may be able to claim a home office deduction for the portion of the residence used. However, in order to qualify for the deduction, the area of the home must be exclusively used for the business. Any area used for personal reasons will not qualify. For example, if you use a room of your house to solely store inventory, you can claim home office expenses for that room. On the other hand, if you host parties to sell products in your living room you will not be able to claim a deduction for the living room as it is used for personal reasons.

Transportation-Related Business Deductions

As a direct seller you can deduct certain transportation expenses. Generally, the costs of travel between your home and the first and last business stops of the day are nondeductible commuting expenses. However, the costs of going between home and a temporary work location are deductible, if you have a regular work location away from home. If your home qualifies as your principal place of business and you take the home office deduction, you may be able to deduct the daily travel costs between home and another work location in the same business, regardless of distance and whether the other location is permanent or temporary. Note that any personal transportation expenses remain nondeductible, even if your car advertises your business.

Additional Business-Related Deductions

One major tax pitfall direct sellers encounter has to do with sample and demonstration products. If you keep some of a company’s products on hand in order to show them to potential customers, those costs may be deducted. However, if you expect to sell the demonstrator kits or products rather than exhaust its value, they should be counted as inventory. In either situation, if the products are used for personal reasons, its cost is not deductible, even if you occasionally show it to prospective customers.

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Mike Slack

Mike Slack

The Tax Institute, H&R Block

Mike Slack, JD, EA, is a senior tax research analyst at The Tax Institute. Mike leads research teams focused on business and investment tax issues.