Taxes

Who is Required to Have a City Business Tax Certificate?

If you do work within the city limits, where ever you are, there is probably a business license requirement.

Here is a quote from the City of Santa Rosa’s website:

 “Any person whose business is located in the city or conducts business in the city must apply for a business tax certificate within 30-days of the date the business commences. Conducting business in Santa Rosa without a business tax certificate can result in penalties, violation notices, citations and court action.  Whether you’re operating from home or a storefront, office or industrial park, you’ll need a Business Tax Certificate.”

As you can see, cities are anxious to register your business and collect a business tax!  Is your city the same?  Fortunately these taxes are usually very small but they do require some extra paperwork.

Go to your city’s website or call your city hall.  If you’re required to have one, bite the bullet and get it for every city in which you will be doing business.

Do I Need a Resale Permit and Should I Use Resale Certificates?

Yes, if you’re going to have taxable sales you’ll be required to have a Resale or Sellers Permit number and to collect and remit sales taxes to your state.

Upon applying, you will be issued a resale number to be used when filing your sales tax return.  You can also file this number with your suppliers (on Resale Certificates) to avoid paying sales tax at the register when making purchases for resale.

I choose not to file Resale Certificates with my suppliers.  Because of this, I pay sales tax on my materials even though they will be resold.  The benefit to me is that I have a much smaller sales tax bill when I file my sales tax return.  Why do I owe less?  The reason is simple: my tax liability is smaller because I am credited at the end of the year for all of the sales tax that I paid on those purchases.

For example, if I sold $20,000 of taxable materials to my customers last year at the 7.5% tax rate, I would have collected $1,500 in sales tax from my customers.  However, let’s say that those purchases for resale cost me $16,000 on which I paid $1,200 in sales tax at the time of purchase.  At the end of the year I would only owe $300 in sales tax to the state instead of the $1,500 that I collected from my customers.

$20,000 x 7.5% = $1,500 collected from customers.

$16,000 x 7.5% = $1,200 paid at time of purchase.

$1,500 – $1,200 = $300 sales tax liability.

If you choose to give resale certificates to your suppliers to avoid paying taxes on your purchases you will end up with a larger tax liability at the end of the year ($1,500 vs. $300).  Additionally, states base the frequency of your returns on the amount of sales tax due.  You may find yourself being asked to file more frequently (quarterly vs. annually).  Ugh, that would mean more tax planning and additional paperwork.

One more added complication of purchasing on a resale certificate is that you will be liable for sales tax on any of the tax exempt purchases made for resale that are later withdrawn for personal use.  The total purchase price of these items must be tracked and entered into the tax return to correctly calculate your tax liability.

For my business, I’ve decided to just keep it simple and avoid the use of resale certificates, effectively paying my sales taxes as I go.

Should I Incorporate My Handyman Business?

What legal business structure should I choose?  The three most commonly chosen legal business structures are Sole Proprietorship, Limited Liability Company (LLC), and S Corporation.  Because I am not a lawyer or a tax attorney I am not qualified to recommend one structure over another.  I can only tell you what I have done and strongly recommend that you consult with an attorney and an accountant before making your final decision.

I chose the simplest and most basic structure you could set up, with all of its benefits and pitfalls – the Sole Proprietorship.  As a Sole Proprietor income is reported on the individual income tax return (1040, Schedule C) so there is very little additional paperwork.  If you choose this option you represent the company legally and fully and you are personally liable for all debts and actions of the company.  If something went drastically wrong with a job you completed your assets could be at risk.  This makes it very important to carry sufficient liability insurance.

I suggest you seriously consider forming an LLC, particularly if you have a lot of personal assets and/or will be hiring employees.  Since the handyman trade could be considered a high risk industry, many handymen choose this option.  This structure affords the members (owners) the liability protection of a corporation.  Unfortunately, this liability protection may not be complete as you could still be held personally liable for your actions if you have signed a personal guarantee.  Personal guarantees are often required by banking institutions if you get a business loan.

A third option, often chosen by contractors is the S Corporation (Small Business Corporation).  This structure allows the profits to be taxed in a way similar to a Sole Proprietorship avoiding the double taxation problem inherent to the corporate system.  As with the LLC, the presence of a personal guarantee would leave the owners personally responsible for debts.

For inexpensive legal advice I became a member of Pre-Paid Legal Services.  This is an extremely low cost legal service that I have found to be a great asset.  For less than $20 per month you have legal advice that is just a phone call away.  It’s a lot like having a lawyer on your payroll!  Pre-Paid Legal associates are easy to find and they will be glad to sign you up.

About Record Keeping and Taxes

Federal income taxes, state income taxes, city business license tax, sales tax, payroll taxes, wow!  Taxes and recordkeeping can be quite a load.

Your record keeping will make or break your business success.  Setting your books up correctly from the start will make everything easier when it becomes time to prepare your taxes.

Here are some keys to success:

  1. Open a separate checking and savings account for your business.
  2. Get a new visa card strictly for your business use.
  3. Keep all of your receipts, job invoices and bank statements.
  4. Purchase a box of file folders to store your receipts, invoices and bank statements.  Keep them in a file drawer or file storage box organized one folder for each month.
  5. Keep separate files for insurance, sales tax, business taxes, and licensing.
  6. Maintain mileage logs reflecting odometer readings and job names.
  7. Use a computer based bookkeeping system and set up your chart of accounts as shown below.
  8. Keep on top of your bookkeeping.  Don’t let it pile up!
  9. Be aware of the different sales tax rates you may have in your area.  In my immediate vicinity there are four different sales tax rates.  Because of this, I keep track of my sales by area. This helps tremendously when the time comes to complete the sales tax return!

I do all my own bookkeeping and file the returns myself.  I use Quicken® because it is inexpensive and easy to use.  Any bookkeeping system should help you successfully track income and expenses and easily complete your taxes.

Do I Need an Accountant and a Bookkeeper?

Unless you’ve had a lot of experience with taxes, you may want to have a tax preparer complete your first year’s tax returns.  In subsequent years you can often prepare your own taxes by following last year’s example.

I have found that after the chart of accounts has been set up properly your bookkeeping system simply requires maintenance. Bookkeeping software has greatly simplified this once difficult task and has made it possible for someone like myself, who has moderate bookkeeping and tax experience, to do it myself.

Alternatively, you may have a spouse or partner available to do the bookkeeping.  If their time permits, in addition to preparing the deposits and paying the bills, they could answer incoming phone calls, contact clients regarding scheduling and make follow-up calls.  Your time would be freed up to make estimates and complete more jobs.  This arrangement could ultimately translate into better customer service for your clients and more income for you both.

The most important thing is that the bookkeeping and taxes be prepared accurately and on time.  Accountants and tax preparers are called experts for a reason, bring them in if you need advice and to save yourself time and aggravation.

What Should My Chart of Accounts Look Like?

Since the 1040 Schedule C is your basic profit and loss statement, I set up my chart of accounts to match the Schedule C as closely as possible.  You should need very few categories that aren’t listed on the Schedule C.  If your state has a sales tax and you have differing tax rates in your area you should break down your sales by tax region.  Also, keep track of tax paid on materials purchases by tax region.

Chart of Accounts

Income Accounts

Labor Sales (Broken down by sales tax region)
Materials Sales (Broken down by sales tax region)
Sales Tax Collected (Broken down by sales tax region)

Expense Accounts

Advertising
Car and Truck
Contract Labor
Entertainment
Equipment Rental
Insurance
Interest
Legal and Professional
Non-Tax Paid Purchases  (Broken down by sales tax region)
Office Expense
Purchases: (Cost of Goods Sold)
Repairs
Supplies (Not Cost of Goods Sold)
Tax Paid Purchases  (Broken down by sales tax region)
Taxes and Licenses

Employee Wages (If you have workers)

Wages
Federal Tax Withholding
FICA
Medicare
SDI (State Disability Insurance)
State Tax Withholding

Do I Need to Keep a Mileage Log?

Yes.  At the time of this writing, IRS Form 2106 instructions (for 2008 returns) had this to say about record keeping for your vehicle: “You cannot deduct expenses for travel…unless you keep records to prove the time, place, (and) business purpose…of these expenses.”

I keep a small spiral notebook in the visor of my truck.  Each morning I list the names of the jobs I’ll be doing and the current odometer reading.  As I go from job to job, I record the odometer reading.  At the end of the month, this page is torn from the book and added to the file that I keep for each month’s receipts.  (Every month has its own folder.)  When matched with invoices these logs serve as my written record of mileage and business purpose.

In the same spiral notebook; record the money you spend for gas, insurance, registration, maintenance and repairs of the vehicle.  Save your receipts.  At year end you will decide whether to take the standard mileage rate or actual expenses on your taxes.  Check the tax codes for limitations and for the current mileage deduction rates.

Are Labor and Materials Sales Subject to Sales Tax?

Since every state has different guidelines, the best suggestion I can make is to use the local state sales tax office as a resource and follow their instructions to the letter.  I am lucky enough to have a state office located in our city so I opened my account in person and asked a lot of questions.

Collecting the correct sales tax can be tricky and the rules are full of pitfalls.  Is labor taxable?  What about materials sales?  If you tell someone that the cost of the job will be $500 is the entire amount subject to sales tax or just the portion that covered the materials?

If your materials and labor are both taxable, your sales tax liability will be MUCH higher.  In my business, labor accounts for about 85% of my total revenue so the stakes are high.

In California, because labor is generally not taxable and materials sales are, you have to be very careful how you quote prices and fill out your invoices.  You must clearly break materials out from labor when quoting the work and while totaling the invoice. If you don’t you might be liable for sales tax on the entire sale.  I always quote labor and materials as separate items.

How Should I Manage My Money for Taxes?

Many business people have found that in their first year in business, the biggest challenge is keeping the doors open and paying the bills.  The second year another problem arises…how to pay all of the income tax!  Because there is a lot more money flowing in the second year they find themselves spending too much and having too much fun.  Unfortunately they don’t foresee how large the impact of taxes can be and don’t set enough aside for taxes.

The good news is that your overhead as a handyman is low and you should be earning a profit early on.  The bad news is that you will need to plan for taxes right from the beginning.  The best way to handle this is with a savings account specifically for taxes. Every time you deposit your earnings, deposit 20% of the total into your tax savings account.  Yes…20%.  Want a different number?  An alternative is to transfer funds at month end after you’ve closed your books and calculated your profits.  Transfer at least 35% of your net profit after expenses.

I know from experience that this is not easy.  So whatever you do, make deposits regularly into your tax savings account.  Use these funds to make quarterly estimated tax payments to the IRS and to your state.

Quarterly tax payments?!?  Yes, otherwise known as Estimated Tax Payments, these are a sad reality of working for yourself.  These are the equivalent of withholding from your paychecks.  The federal government and most states want to be paid throughout the year, not just at the end.  They’ll penalize you if you don’t make payments at least four times a year.  (IRS due dates are Apr 15, June 15, Sept 15, Jan 15)

The percentages I’ve given are obviously an estimate.  Unfortunately, you may not know exactly how much you need until it is too late so save all that you can and as often as possible.

If you’ve been generous with your tax savings account you will find that the estimated tax payments won’t be so painful after all.  At year end, after your income and sales taxes are paid, you may even have money left for that hard earned vacation.  It’ll be just like getting an income tax refund!

Can I Open a SEP-IRA Retirement Account?

According to the IRS; businesses, corporations and self-employed individuals can open retirement accounts including the SEP-IRA.  As a self-employed handyman the amount you can contribute is dependent on your profit for the year.

It is not easy to calculate your allowable contribution.  Always looking for a bargain, I opened a SEP-IRA at one of the large discount mutual fund families.  Their retirement planning department was great about answering my questions, they calculated my allowable contribution and all of their advice was free! Check with a tax professional or a financial planner to see if you qualify.

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