In this day and age, it’s hard to go a day without seeing somebody selling a product for some type of multi-level marketing company, or what we call MLM. Being part of an MLM can bring some interesting tax misconceptions.
To discuss this, I have brought Heather Whitten from one of our offices at Hawkins Ash who specializes in this area to join us. Welcome, Heather!
You have been working with clients involved with MLM for a long time. What would you say is the most common misconception?
The most common misconception is that once you sign up to sell for an MLM you can just start deducting personal expenses on your taxes that you normally wouldn’t be able to. I am sure you’re familiar with that saying, “If it sounds too good to be true, it probably is.”
We have all seen people posting online, especially on Facebook, who are promising low hours, big money and large tax deductions just for joining their team. In the past, I have heard of people saying they can deduct their mortgage/rent payments, cell phone and internet expenses, subscriptions like Amazon Prime, even pet expenses—all because they are a part of an MLM. That’s simply not the case.
Are you saying that none of what you mentioned are eligible for tax deductions?
I am not saying that at all. There are many great, legitimate tax deductions you can utilize to reduce your income from being part of network marketing. However, there are limits—like with everything.
Let’s touch on deducting your rent/mortgage expenses.
Most of us have seen the movie, “The Accountant,” with Ben Affleck. There is a great scene where Ben Affleck’s character, who is a CPA, goes to a client’s house and is giving them bad news about the tax they owe. As they are sitting there, Ben notices some jewelry pieces on the table. What results is he convinces the couple they have a home-based business and they can deduct home office expenses because they work at the kitchen table—that’s lowering their tax burden. I guarantee you every accountant who saw that scene cringed just like I did, because it’s factually incorrect. The home office deduction can be an incredibly lucrative deduction, but there are pretty strict rules.
The biggest rule is that in order to deduct a portion of your housing expenses, you must have a room that is exclusively used for your business. You can keep inventory and record your Facebook Live videos in there, but if your children decide to use that space to do homework or if you’re trying to claim the family living room as an office, it doesn’t qualify for the deduction.
You mentioned deducting your cell phone and internet expenses before. I assume if I’m conducting my own business over Facebook Live, that I can deduct pretty much all of my phone and pretty much all of my internet costs. Is that right?
Unfortunately not. Like all things when you are self-employed, you can only deduct a portion of your expenses that are used for business. For instance, if you spend two hours a day using your phone for business and six hours a day for personal purposes, only 25 percent of your phone expenses are business. That’s the case for everything: Internet, computer, even your Amazon Prime subscription.
It would be really hard for me to figure out how much of my Amazon Prime purchases are actually for business, and how much are for personal use.
It can be. Thankfully the IRS allows a reasonable explanation. You can keep track as best as you can with the logs. Otherwise, the easiest way is to completely separate business and personal. It might be a pain having two phones or two Amazon accounts, but it will save time and effort with record keeping in the long run.
What else should we know before considering jumping into an MLM-type business?
The biggest thing people can be unaware of is that when you sell for an MLM, you’re an independent contractor. One hundred percent of commissions you earn will be reported to you on a 1099 and you will be subject to self-employment tax, in addition to regular income tax on those earnings. The potential higher tax makes it important to claim every legitimate deduction to which you are entitled.
If I’m worried about my income this year being too high, can’t I just buy a bunch of stuff at the end of the year and take it as a deduction?
Unfortunately not. If you make $10,000 in product purchases during the year but only sell $7,000 of that, you cannot deduct the remaining $3,000 in that year. You have to include it in inventory until those products are sold.
You mentioned something at the beginning: Can people really deduct pet expenses on their tax return?
Most of the time they cannot. There are very few instances where unusual deductions like that are allowable. That’s why it’s important to work with a tax professional who can advise you before you take a risky tax position and end up in trouble down the road.