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In the USA, say Jane is a 1099-type worker - she's self-employed.

She has various expenses which are generally deductions from her profit, but note that...

https://www.irs.gov/businesses/small-businesses-self-employed/what-kind-of-records-should-i-keep

Looking at that document, the IRS in the US seems to distinguish between "purchases" and "expenses".

("Travel" is a third category, also handled differently.)

Say Jane is the typical type of freelancer, designing sets or writing articles. She has "expenses" (electricity, etc etc), but probably no "purchases".

So normally for a client she will make some drawings, and get $20,000 for that. That's that. At the end of the year she's grossed 100k and has a few expenses (electricity, etc).

However, let's say that during the year she happens to "make something" for a client,

So, she says "I'll build that Bedroom Stage for you." She

  • buys some beds, lights, and other props, $10,000
  • builds the thing, hands it over to the client, and gets $40,000

It seems she fair-and-square had "purchases" as the IRS defines it, of $10,000.

In fact, can 1099 workers actually do this sort of thing?

Or do you have to be some other type of corporation, or?

There seems to be a couple problems,

  • The economics are different. A typical freelancer might make 100k in a year; expenses (electricity, travel etc) are a few thousand. Whereas, if you are "making stuff", it would be completely normal to have (say) 600,000 coming in and 500,000 going out, ie purchases can be a huge fraction of the gross.

  • It would seem to be open to abuse, perhaps the IRS really clamps down on this sort of thing? Having "purchase" type items, would seem to be a red flag? ("I bought a big TV and a Rolex - it was used in a client 'product', honest!")

Again my questions are,

  • Indeed can 1099-mode workers even actually claim the "purchase" type?

  • If so, is it sort of a red-flag and flakey area??

Indeed, do you have to perhaps define your business as some sort of special entity (a "producer", "manufacturer" or something?) Are there other issues anyway - sales tax??

  • Did anything catch your eye that made you think perhaps she couldn't claim the $10k? – Hart CO Apr 6 '18 at 15:28
  • Have you read Schedule C? – JoeTaxpayer Apr 6 '18 at 15:30
  • @HartCO - right: to be clear, in that document, it doesn't really explain "who they are talking about". I don't know if it's a sort of "general right" ("citizens can do this....!") or if it only applies in some context of a business or corporate structure. – Fattie Apr 6 '18 at 16:49
  • Your 'third category' Travel, Transportation, Entertainment, and Gift Expenses is, as the word Expenses indicates, a sub-category of Expenses, but a sub-category that due to past abuse you are required to keep specific records to justify. You should keep good records for everything, but if you don't, these items are automatically rejected whereas for others they might accept alternate forms of proof. See the Most Litigated Issues section in any (or every) annual report from the Taxpayer Advocate. – dave_thompson_085 Apr 6 '18 at 20:10
  • all great info, @dave_thompson_085 – Fattie Apr 6 '18 at 20:35
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Indeed can 1099-mode workers even actually claim the "purchase" type?
If so, is it sort of a red-flag and flakey area??

All small business expenses are subject to scrutiny, hence the record-keeping requirements, but they are certainly allowed and necessary since our income tax is on business income not revenue. Whether or not her income gets reported on a 1099, she can certainly offset her $40k revenue with the $10k in materials you mentioned. While allowed and necessary, my guess is that small businesses fudging expenses is one of, if not the most pervasive forms of tax fraud.

The primary reason for separating out the two expense types you mention is that in general we don't count inventory as expense when you purchase it, but when you sell it. We call that Cost of Goods Sold. Not as relevant in your example, but say she bought enough materials to make 4 of these stages and only sold 1 in the same year she bought the materials, she'd only offset her income by the cost of materials associated with the one she sold that year. While the utility bills each month are expenses when incurred regardless of sales.

  • Ahh ... "The primary reason for separating out the two expense types you mention is...". This may be the confusion. Looking at that IRS doco, there are four categories they list. "purchases - expenses - travel - assets". Indeed, there are very different IRS rules and procedures for "travel vs. assets vs. expenses". Are "purchases and expenses" simply "the same thing", they are NOT different categories, not handled differently? That doco. is a bit confusing, then. – Fattie Apr 6 '18 at 16:52
  • Thus, notice the question says ........ "Looking at that document, the IRS in the US seems to distinguish between "purchases" and "expenses"...." is that simply wrong? – Fattie Apr 6 '18 at 16:53
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    They are handled differently, inventory/materials means an accrual approach rather than a cash approach, but they are all business expenses, not reserved for certain types of business. – Hart CO Apr 6 '18 at 16:53
  • OK. I think I get it. – Fattie Apr 6 '18 at 16:54
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    Its worth pointing out that a number of states have "gross receipts" taxes, which is a tax on revenue and typically only applicable to certain business types. – quid Apr 6 '18 at 18:02
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There is no such thing as a "1099 worker" or "1099 employee." A "1099 worker" is a contracted small business, the business might have only a single employee. That "1099 worker," really just a contractor, might be structured as a simple sole proprietorship, it might be a LLC it might be a Corporation (C or S or whatever) it might even be a 501(c)(3) non-profit; though a 1099 is not required to be furnished to corporations.

Business A is paying Business B as a contractor. Business A records the expense of paying Business B and reports that expense via Form 1099. If Business B buys materials that will be used in completion of a contracted project, that's an expense to Business B. The fact that Business B has only one employee and the 1099 was issued to that employee as an individual and indicates that individuals social security number doesn't mean some expenses are off limits; it just means Business B is a sole proprietorship.

Though, many states want you to maintain a business license to operate in that state. Many many many self-employed single-employee small businesses accidentally run afoul of business licensing requirements because they think they are a "1099 employee" of whatever company is paying them and reporting it via 1099.

Single employee service companies should typically run on a cash basis. You'd have to have some really unusual circumstances to run a single employee sole proprietorship service based company on accrual accounting (primarily because you'd book income before actually receiving it). But your regular expenses are expenses, your materials or costs directly related to a contract job (including outsourcing another contractor) are expenses, your electricity bill is an expense, your computer is an expense, etc. Inventory (not relevant to your specific question), items you buy with the explicit intent of selling to a customer through your normal course of business, with some very narrow exceptions, is always handled on an accrual basis; in this case you would probably run on a "modified cash basis" because you still don't want to book income before you receive it. Your rolex is never a business expense. Unless your business is reverse engineering rolexes or crushing things and posting the video on youtube.

  • That's a good point about state licensing. As you say, inventory is expenses, material is expenses, electricity is expenses, etc. Consider, "car mileage" is expenses .. but the IRS handles it differently. The page mentioned in the question gave (me anyway) the impression that they handle "purchases" differently. But, thanks for clarifying! – Fattie Apr 6 '18 at 20:09

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