The Seven Deadly Sins of the Self-Employed (at Tax Time)

It is a statistical fact: Self-employed individuals are much more likely to get audited than regular employees. So we are sharing what we consider to be the Seven Deadly Sins when it comes to being self-employed and your taxes:

1. Not knowing what you owe. There are 20 different 1099 forms that get sent out to workers to track freelance gigs. One of them is the 1099-MISC, which has to be sent to you by a company if you make over $600. People think – Great, no paper form, no taxes on that. But that’s a big mistake – you still have to self-report the income.

2. Not knowing WHEN they owe. For freelancers who owe more than $1,000 in taxes for a year, tax time comes more often than just April 15th. They have to pay taxes quarterly. But then it’s not coming out of paychecks like it does for permanent employees.

3. Not tracking and writing off the right types of business expenses. Many freelancers fail to realize they can write off part of their cell phone bill as a business expense. Expenses vary by the type of work. A rideshare driver’s biggest expense will be related to their car, while a web developer’s biggest expense might be their home office. Figuring out what expenses are important to your type of work is important is maximizing your tax savings.

4. Writing off personal expenses. This goes back to that cell phone. If you use the same phone for personal and business purposes, don’t be tempted to write the whole bill off. Estimate the amount you use it for your work. The same goes for your vehicle. Don’t go trying to write off miles driven to the beach.

5. The Double No-No: counting expenses twice. Speaking of vehicles, most people use the Standard Mileage Rate ($0.56/mile for 2014), which factors in gas, repairs and maintenance and other costs like insurance and depreciation. But if you use this rate, you can’t also expense your gas receipts and repair bills.

6. Employee AND employer. Freelancers they play both roles. For regular employees, Federal, State, and payroll taxes are withheld from a paycheck, and distributed on the employee’s behalf. It’s how Social Security and Medicare are funded. The IRS mandates that the employer must pay half of every employee’s payroll tax, and the employee is responsible for the other half. Independent contractors have to handle both halves. The IRS does give you a small benefit by letting you deduct the half that you pay yourself as a business expense but don’t believe that because of this a freelancer pays less taxes than the regular wage-working employee.

7. Not keeping adequate records. The IRS requires you to keep proof of all business receipts, mileage, etc. If you can’t show these, the IRS could refute the expense and force you to pay back taxes. The good news is there are other ways to prove expenses if you’ve lost the receipt. A bank or credit card statement with the date and location might do the trick. The IRS may be accommodating if you are doing your best but if you’re being a headache, they’re going to be a headache as well.

What the tax man looks for.

A tax auditor is looking for certain things when they audit you and your business. The IRS training manuals note that the auditors are examining you and not just your business tax return. Your lifestyle may be checked against your reported income to see if there is a discrepancy which shows skimming, diversion of funds or deception. For example, that mansion with the truck-mount van parked out front may send up the wrong “economic reality” flag.

Travel and entertainment deductions in a business are usually suspect as some people try to deduct personal entertainment and meal “business” expenses. You must be able to clearly explain the business relationship in a credible fashion. Taking your friends out to the ballpark or taking the family on a vacation to that industry conference may not quite pass the litmus test of an audit. Writing off your legitimate business entertainment expenses requires detailed explanation of the reason for the expense, as well as a receipt.

So please be aware of these things and help us help you when it comes to your taxes!