Jen Casey (JC):For anybody that’s thinking “Oh wait, this is about taxes?” We’re not necessarily going to go deep into taxes, but I think this is an important conversation. I would love for you to shed some light on some of the potential scenarios that could happen if you ignore the numbers in your business.
Katie Ferro (KF): If you’re ignoring your numbers, the cold hard truth is that you’re probably not succeeding at all or you’re afraid to look for whatever reason. You’re getting too bogged down and too busy to take time to look, and I relate it to trying to lose weight without looking at a scale or paying attention to how your clothes fit.You’re using no way to measure it.
In 2019, especially if you’re online like we are, there’s all of these small costs that can add up. You may make a good chunk of money, but you may spend more money than you just made in sales and lose money, which is ok in the beginning, but you want to turn that around as fast as possible, and the only way you can do that is by knowing what you’re doing. One of the things that I’ve been working on is working out how to set a sales strategy to meet your goals with sales to begin with, how simple that process can be, and how powerful it is because then you know how much you need to sell in order to actually make the sales that you want to.
You’ll have a goal in mind and a way to get there instead of just hoping for the best. Whatever your sales are, minus your cost, is what you’re really making. I’m talking about profit or loss because a lot of small businesses lose money. Like I said, that’s ok, you just want to be able to turn it around. If you’re a sole proprietor, you’re paying self employment tax, and it’s 15.3 percent of your profits. So if your business is making a profit, you’re going to pay more in taxes than you would as an employee. That money isn’t just being paid to Uncle Sam for you, you’ve got to do it yourself or budget for it. At the end of the year, that really can add up if you’re not putting it aside and just knowing that it exists.
JC: Some people get completely blindsided and then have to pay three years worth of back taxes and they get stuck in this spiral. I know many successful ‘on paper’ entrepreneurs who, early on, kind of got stuck in a mess, and on paper they’re still making six figure or seven figures, but they owe hundreds of thousands of dollars.
KF: That’s such a good point and that’s what I try to explain to people. You can’t put it off and you can’t wait on this. You have to know what you’re doing up front so that you can manage it. If you know that every hundred dollars that you make, 30 of it is going to go to taxes, then you won’t keep reinvesting it into your business. That’s what a lot of people do in the beginning. They take their profits and they spend it back into their business. I am a big believer in reinvesting into your business, it’s just that you can’t get yourself deeper into a hole than you can pay back.
I was talking to a creative entrepreneur whose business has just starting to take off. She’s getting high-end clients, but the profits aren’t there. She came to me in October of last year and the extension deadline for 2017 had just passed. I asked her for her tax returns and she gave me just her business return, and the way that her business is set up, that’s where she reports her income, but not where her taxes are paid. Her taxes are paid on her personal returns, so I said, “Can I see your personal too?”
That was when it was discovered that her accountant didn’t file her personal taxes and she didn’t know any better because she thought her taxes were filed. I guess she thought her business didn’t make enough money to pay taxes. She just didn’t know.When it came time for the accountant to fix this, it was already the end of 2018, which means for all of 2017 she put no money into taxes. Her return has now passed extension and it’s all of 2018 that she hasn’t been paying taxes either, so she’s two years into this and now on a payment plan with the IRS from 2017.
She has not paid anything to 2018 and now we’re in 2019, and I’m saying she should be putting it aside and budgeting for it. Well right now, she’s too busy trying to pay off two years ago. If her business profits, I don’t know how long all of her profit is going to go to the IRS. It could be managed better. Partially, some of it could have been saved, but instead of spending it in other places, she had to pay to the IRS because now it’s this compounding nature of paying penalties and interest on that until you pay it back.
JC: It just becomes such an unnecessary mess, but like you said, people don’t know what they don’t know, and if they have someone who is an accountant who maybe doesn’t handle more of the online world, there can be a little bit of a hiccup.
KF: I spent a couple of years in a CPA firm so I know exactly what that environment is like as an accountant. I know what it’s like to be an entrepreneur and I know what people in the startup phase are actually doing and focusing on, so I see how it happens and I think the biggest thing is it’s just a communication gap.
The typical account is very busy come tax time when everyone wants to suddenly have a conversation about a year that’s already done, so there’s no planning involved. Now in February of 2019, it’s tax season and your accountant is swamped and everybody and their mother, quite literally, is reaching out to them. They are working 70 to 80 hours a week, if they’re lucky. Most of them are working more. You’re bringing to them history… they can’t change that. If you contact them in the beginning of the year or when you’re starting your business and you talk to them, then they can help you plan it and help you set up your business in a way that makes sense for you and your business.
Entrepreneurs are coming to accountants when accountants are swamped and some have this mentality of ‘turn ’em and burn ’em’. Some operate like that. Not all of them, but a lot of them are focused on how many hours it takes to sit with a client. Ten minutes explaining a tax concept to somebody who’s really budget conscious, somebody who doesn’t want to pay them fifteen hundred dollars to prepare their return, is not going to get the conversation that they need to really change things in their business. They’re just going to spit out an answer that’s the best thing that they can do for what’s already been done, and then they’re not going to see them again for another year. It’s just this big communication gap and I think that a lot of accountants have a tendency to think that the entrepreneur doesn’t want to know. They just want it done. They’re not really teachers.
JC: Well, that’s not the responsibility of an accountant to teach somebody how to run the money side of their business. I guess I’m biased!
KF: Yeah, I think that just explaining the basics would go so far and I think that a lot of people are really intimidated when they sit in a typical CPA office, if they ever make it there. I think they’re intimidated because there’s a lot of big, weird words flying around at a quick pace and I don’t even know that they know what questions to ask to make sense of it all.
They don’t say anything or ask anything and then the accountant is like, “So, we’re good?” I just feel like it’s a big communication gap.
One of the things that I want to help entrepreneurs do is know how to navigate their relationship with their CPA better, know when to ask questions, know what questions to ask, and just what kind of items they should even be talking about and bringing up. If you’re dealing with a 50 year old man, no offense, and you’re talking about how you sell crafts on Etsy, they just may not even know what Etsy is and maybe they think sales tax is handled, and unless you ask, “Do I have to deal with sales tax?” They might not even be thinking about it.
If it’s not brought up what you do and that conversation isn’t had by the entrepreneur or the accountant, then you may be missing things other than just income tax.
JC: This is so important. Just to put a little button on that, what is a general safe number that people can save, percentage wise, to their income that they can start doing right now? Maybe throw it in a capital one 360 account just to have that money away from your checking accounts so you don’t spend it.
KF: I think that’s a great question and it’s so dependent on everything else in your life. Are you a one woman show, not married, no kids, sole source of income? Or do you have a day job and a husband with a regular salary, which would mean that withholding is going in, and you’re going to be able to write off your house and your kids? Then your business may not affect your taxes that much.
If you’re in a stage where you’re not profiting, you’re going to actually see money back from your business that’s not profiting. That’s why I think it’s so important to see what your numbers are telling you. Are you profiting? If you’re profiting, you’re going to need to be paying tax. If you are not profiting, you’re either going to have a refund or just not owe anything yet. You should still file because you’ll be able to use that loss when you do start making profit, which is the goal. But if you’re profiting and your business is largely your source of income, then I would say somewhere between 20 and 30 is a good ballpark.
This is individualized to the way that you like to manage your money because some people would rather put aside less and pay, but they know that they’re the kind of person that might have that money in the bank or be able to come up with it. So if you’re only putting 20 percent aside knowing that it might not be enough, but you’re ready to cough it up come tax time, I think that’s totally fine.
If you’re a big spender and you’re not sure that you’d be able to pay it, then I think it’s smarter to put more money aside, have it there, and then you can take the excess and do something with it, whether it’s hire that VA that you’ve been thinking about, go on a trip, or do something for your house. You can consider it like your own tax refund.
JC: I didn’t know this when I started my first online business. Obviously I’m not network marketing now, but especially for those in network marketing, they believe that it’s taken care of and don’t even really consider that they don’t get to keep and spend all of the money they made.
KF: Yeah! This happened to me and it’s funny because I’ve been a numbers person my entire life. I started serving tables when I was 16 at Johnny Rockets in the mall and I had a spreadsheet. I would come home every night, put it in a spreadsheet that calculated my hourly wage, and I did an 80-20 split of savings. It was insane. I wish I was still that diligent. I knew what I made per hour. I could see that I would have really bad shifts, but overall I was still making 20 dollars an hour because I had a really good shift, and it kept me more mentally in the game for the bad shifts. I did this all throughout the time that I was a server. Always had a spreadsheet by a month.
My first college degree was accounting and then I got a Masters in tax. While I was getting my Masters in tax, I was running photo booths for a guy. He had a photo booth company and on weekends and nights, I would go and stand at the photo booth for 30 dollars an hour and I was like, “This is nice extra money while I’m in college.” I think I made twelve hundred dollars. Then I got a 1099, and it was my first experience with that. I was I was studying tax, but sometimes they don’t tell you the really practical things. They tell you crazy complex tax law and not, like, “Hey, if you pick up a side job, you might get a 1099.”
I got a 1099 and while I was doing my taxes myself, all of a sudden my refund went away and I owed something. I’m like, “How did that happen???” That’s when I researched self employment tax and that’s when I realized that more than 30 percent of what I made went to taxes because I was already making a decent salary, so I didn’t get any kind of nice perks and I had to pay my regular tax rate on that income plus the 15.3 self employment tax, so I paid 30 something percent. If I had known this, I would not be driving to Miami and standing outside of a photo booth because the great money that I thought I was making was, I was only making 60 percent of that, and that wouldn’t have been worth it. I was frustrated.
When network marketing happened and I started seeing it blow up, I would just think, “I wonder if this person is making money, and if they are, I wonder if they know about the self employment aspect of this.”
I have a lot of conversations with different network marketers in different companies because they’re all a little bit different. In some of them, there’s all this focus on how to make sales and how to gain confidence as a sales person. How to close deals, how to reach people, how to market yourself to get heard by a lot of people, but there’s nothing when it comes to this because, I think, it’s liability. They just don’t want to advise you on those things and it’s really your responsibility as an entrepreneur, so that makes sense. It’s just a shame that there is such a hole there.
JC: I couldn’t agree more and I think it’s not just the network marketing companies. I think it is also a lot of people who are teaching business, and this is not to say that that’s necessarily wrong if your area of expertise is sales and marketing. I mean, mine is. I also try to bring in experts, people like you, who can speak a little bit more eloquently to the other side of business that is necessary.
I mean, you can make sales all day, but if you are bragging about how you’re making 6 and 7 figures and you’re actually in the red and selling business courses, it’s just crazy. I think that’s a big reason why, especially in the last year and a half, I really stopped talking about my sales online. I know that that’s still a big thing that people use as a way to get more customers, but I just felt like, unless I was going to be unveiling every single piece of expenses and ad cost and give a full de-brief every month, then I wasn’t just going to just talk about sales because it was really painting an unfair picture for the newer entrepreneurs who were thinking, “When I hit six figures, all my problems are going to disappear.” It’s not actually the case.
I had gone to Tony Robbins’ Business Mastery and Keith Cunningham did a whole two day, eight hour segment on understanding your numbers and accounting. I already had a pretty good handle on some of the pieces, but after that, I started seeing more and more how frequently only a sliver of the snapshot is shared on social media. I think it really is a huge disadvantage to those newer entrepreneurs coming up and not really understanding the scope of what they’re getting themselves into. So I’d love for you to speak to the differences between revenue, profit, and bottom line cash. Not getting too nerdy with this stuff, but just really helping them understand what that actually looks like from an accounting perspective.
KF:I’ve been talking about this so much lately so I’m happy that you asked. You hear people saying they run a six figure business, 100,000 or more. They run a multiple six figure business, which I think might be that they have hit 200,000. And then they run a seven figure business, a million dollars. I’m 100 percent certain that there’s not a person out there that has posted that that’s talking about their bottom line, which is their profits. They’re talking about the first line, the sales.
Just a little background, I am a CPA, I have worked in a CPA firm and I’m very familiar with small business, but in the last few years, I had my first son and stepped out of corporate and will never go back. I found that my passion is in bookkeeping, which is actually so much simpler but so much more powerful and important in your business than taxes are, to me. I think it’s crucial that either you do bookkeeping or you hire someone to do it for you. If you’re going to hire somebody, don’t just pass it off. Ask for the reports and what it means at the end of the month because you need to see what your sales are, but you also need to see your costs by category. Then, you need to see what your sales minus your costs give you. That’s profit or loss. If you’re using a big software like Quickbooks, you have a profit and loss statement. It’s going to show you if you’re making a profit or a loss. Simple addition or subtraction, and it’s really powerful to see it that way.
Then, you’re going to see expenses, and your expenses are your costs and you’re going to see a breakdown of that with advertising or utilities, which could be software. Those would be your utilities. Then you’re going to have office supplies and some functions of your business that you outsource, and at the end of the day, you’re going to have the total of those expenses. Sales minus expenses is going to give you your profit or your loss. I think it’s really important to do this and do it monthly because those numbers tell you so much.
It’s like, “Ok, I made 10,000 dollars!” That’s amazing! Everybody wants that, but did it cost you 20,000 dollars to make that 10,000?
If so and if this is the beginning of your business, I think you’re off to a great start, but there’s three ways that you can increase your profits. It’s really two ways, one with a part A and part B. You can increase your sales or you can cut your costs. If you’re going to increase your sales, you could do that by either increasing your price or increasing your reach. You can keep the price the same and reach more people, or you can increase your prices.
One of the questions that people ask me all the time is how to price their products or services, which at first I was like, “How am I supposed to answer that for you? I don’t know what your products or services are.” I’ve been thinking about it more because I have to decide how to price my products or services. I think you need to do a delicate balance of how much time it takes for you to do something and how many resources it takes for you to do something.
I asked somebody who was starting to sell bracelets because I was curious about the product. I asked her how long it takes to make one, and she said 40 minutes. I thought, “Wow, and you’re selling these for 12 dollars?” So right there, your hourly wage is less than 20 dollars an hour, which would be fine by itself, but how are you ever going to scale that? What is the cost associated with that because that’s your selling price on Etsy, meaning you’re going to lose money, right? Etsy is kind of an expensive platform. It’s also really easy, so it’s great, but you’re going to have listing fees, transaction fees, packaging fees, and you’re going to have to collect sales tax and pay it to the state. In this scenario, how can you make this a job that replaces your day job, if that’s your goal?
JC: Right? Like you said, it’s not scalable, meaning that person is still trading time for money and not doing it very effectively. I think what you’re saying with the profit and loss, we can go even a step beyond that and just highlight that your sales revenue, your profit from the business, whatever that may be, that’s not your salary. I’m like, “Is that six figures since you started? Is that six figures in the last year, in the last five years? Please tell me more!”
KF:I always want to know, but then you’re like, “Do I want to ask this question or what’s the goal here?” Sometimes I think it is constructive. I would like to reach six figures in a year in my online business, and one of the things that I want to focus on right now is finding a way to still make a profit while working very little personally and sacrificing little of my life, but still help and serve my customers, which will help them have more successful businesses and start doing more of what I’m doing, where they’re working less and making more.
I’m starting to outsource my business and it feels so good to give somebody else an opportunity too. I’m like, “Ok, I can’t manage this all on my own, but I have this way to make money, so I can keep a little bit of it and then allow this person an opportunity to make some extra money.” I’ve been bringing on people that I used to work with and moms who have the ability to work at night and I enjoy that. Kind of like spreading the wealth.
My bottom line is going to suffer because I’m outsourcing, but I’m doing less work, so that’s great!
JC: Absolutely. You’re giving these other people, who are maybe not entrepreneurs, don’t want to start something from scratch, or don’t want to be in network marketing, and you’re creating a potentially really great revenue stream for them to stay at home and do their own thing or travel. I know a lot of the people that I have on my team are not trying to start their own businesses and they’re really grateful to be part of something that is already living and breathing.
Speaking to that conversation, we can even talk about employees versus just having independent contractors. When I was first hiring, I really didn’t understand how to set those things up and when to make someone an employee.
KF: Yes, so actually, I have a little course and that’s one of the topics in there. It’s so important to know the difference and understand the difference from both sides. When you’re hiring, let the person you’re hiring know what they are and what it means for them. If you’re the one doing the hiring, you really need to know if you are hiring an employee or an independent contractor. It’s different for you, it’s different for them, and it’s different for the IRS, and you can’t just choose which ones easier.
As an entrepreneur and the one hiring, it’s easier to make them an independent contractor and in a lot of cases I think that’s the right answer, but an employee has things handled more for them, so I guess I am going to have to step back. An employee gets paid on a paycheck from you. You withhold taxes for them. You also pay half of their payroll tax, so you pay 7.65 percent of their wages to the IRS for them and you may pay some marginal amount to your state. How that helps your employee is that you’re covering half of their self employment tax; it is what replaces payroll tax. The IRS gets 7.65 percent from employer and 7.65 percent from employee, so that’s where self employment tax comes from. It’s 15.3 percent, which is those together, because when you’re working for yourself, you’re the employee and the employer, so you get to pay both.
The IRS doesn’t get it with every paycheck. They get it if you pay your quarterly estimated payments like you should and on your return. It’s easier for you, as an employer, to have an independent contractor because you just pay them. There’s no taxes coming out and at the end of the year, you give them a 1099, and that’s self-employed income for them that they pick up on their tax return and pay income tax and self employment tax on. Now, the IRS would prefer that they were an employee because they’re going to regularly get their money and they’re going to get it from you.
The IRS doesn’t want you to just say, “Hey, it’s easier for me to have an independent contractor, so we’ll just do that and see what happens.”
The difference between them is based on this 20-point test that the IRS has, and essentially what those 20 questions ask you is who has control. That’s basically the gist of it. In an employee situation, they would be getting most of their income from you as the employer, you would tell them when and where to work, you would provide them with tools, and they wouldn’t be able to outsource their job. You are controlling them. You’re telling what to wear and where to show up. The alternative is you are working independently and just engaging somebody for some work. The people that I hire are independent contractors because they’re in control. I’m giving them tasks and projects and then allowing them control over how to do those, where to do those, and when to do them. They’re working part time from their home and they tell me their hours and I just pay them for the work done. That’s an independent contractor.
You don’t want to just treat an employee as an independent contractor because it’s not fair to them. They’re going to pay more in taxes and they’re going to have to do more work. You should be handling that for them. If they are an independent contractor, you really should be giving them an agreement that states that very clearly and allows them to know that that is something that they need to manage from a tax point of view.
JC: Thank you. I think that’s such an important distinction and I know so much of the podcast audience is in that transitional place where they are slowly inching toward outsourcing more and building a team. I think just having the clarity around those two things is going to be really powerful for them in doing that.
KF:I really just think that clarifying things from the beginning is so important. Most of the people that I’m engaging have a contract of their own that I skim over and read, and that’s great! The contract part is not my zone of genius, but it is something that you want to look into because that just establishes the relationship very clearly right from the beginning, so that at the end of the year, you don’t give them a 1099 that they weren’t anticipating and then they complain.
Somebody reached out to me last year and said they just got a 1099 that they weren’t expecting. They didn’t realize it was coming. Again, just kind of naive. She was young and didn’t realize that no taxes were being taken out of her check. She just didn’t realize and then she said, “What can I do about this?” It’s the worst when you’re doing a service-based thing as an entrepreneur and you don’t know this kind of stuff.
As an entrepreneur, you need to be careful about paying your employees as employees because, technically, you can get in trouble for that. The IRS is going to make you pay the difference. If it gets brought out that they were an employee and should have been treated like that, especially if you have multiple employees, it can get you in trouble. If it gets discovered three years down the road, you’ll be paying in that portion of employer payroll taxes for all of your employees for however many years it had been going on. You just don’t want to get into that position.
JC: This is an important conversation of prevention, right? Once you get into that place, it can be pretty difficult to dig yourself out of it.
KF: Yeah, it’s almost always years later that something becomes a problem. With sales tax, it’s the same thing. If you’re selling on Etsy, even digital products in certain states are taxable. If you’re doing ebooks, in some states, it’s taxable. If you have online courses, in some states, it’s taxable. You really need to know the rules for your own state. I really worry about Etsy sellers because it’s so traceable. If I had an Etsy shop in Florida, you could actually go to Etsy.com, search by Florida shops, and you’ll see how long they’ve been doing business on Etsy and how many transactions they’ve had. So they could find big dollar shops in Florida, put something in their cart, and see if it charges sales tax or not.
I don’t think that the states are that wise to this yet, but it doesn’t mean that they need to be now. If your shop has been in business for 10 years and you’ve never collected Florida sales tax when you should and it gets found out, if you’ve never registered and filed, there’s no statute of limitations. The state can go back to the first day that you started doing business and charge you sales tax on all of your sales and it will be so easy for them to do because everything in 2019 is online with a report that you can run.
The IRS can go in and pull your records from whatever cart you use, Etsy or anything like that. If you’re selling on Uber, they’ll be able to see all of your commissions. Everything like that is so traceable. You have to be diligent and making sure that you’re not making mistakes that could be traced back to the day you open shop, and then you’re hit with the tax you should have collected, PLUS penalties and interest!
JC: That’s so interesting for something like Etsy, being as big as it is today. I mean, maybe they just want to stay out of the weeds of having to update all of their information around that, but it’s interesting that they wouldn’t be providing their sellers with at least a heads up that they should go look into this for their state.
KF: Well, I think it’s there somewhere. I’m sure it’s there, maybe you need to read all of the fine print or something. If you go in there, there is a whole sales tax part, accounting taxes and sales tax, that can be turned on. But it has to be turned on and you have to know what products and what rate to charge, and then you have to file the returns.
Sometimes I see people charging sales tax, which means it’s in their bank account, but they’re not filing returns, which means they’re holding on to the state’s sales tax, which can really get you in a lot of trouble. It’s so easy to make the mistake, that’s the truth. You’re just busy trying to get your listing up and trying to crank stuff out for your customers. I see how it happens.
Etsy is a platform, right? They can’t manage the whole finances of your business. It’s not their job, but there are changes in the works. I’m kind of a sales tax nerd. I worked just in sales tax for a while. It’s interesting to see because the states in 2017/18 lost, collectively, 16 billion dollars in sales tax revenue because of online sales that aren’t being taxed correctly.
Things are starting to change there. Amazon will probably start managing sales tax for sellers. They’re going after the big dogs first. They want to make it as easy to get their money as possible, so if they make Amazon deal with it or Etsy deal with it, then they’re going to get more of their money. Right now, the way that it stands in most cases is that it’s your responsibility as the shop owner to have your sales tax and be paying it.
JC: This is so fascinating. It really just shines a light on how much more there is to running a business, right? We see the pretty, shiny tip of the iceberg. I hope that this conversation for all of you guys isn’t scaring you, but giving you a deeper understanding of what things you need in place in order to be smart, protected and make sure that you’re actually keeping the money that you’re working so hard to get!
