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Freelancer? Avoid These “7 Deadly Sins” at Tax Time
By: TaxConnections
In separate reports, Zen99 and the consumer finance website nerdwallet ranked Los Angeles the best city for freelancers. In 2012, 12% of people in Los Angeles reported themselves as self-employed. Each of these website reports considered housing and health care costs, the percentage of freelancers in the area as factors. Even before the sharing economy began to take off, the entertainment industry and growing tech scene were already strong sources of freelance gigs in LA.
Related Article: Where to Find (and How to Hire) the World’s Best Freelancers
For freelancers, consultants, actors and other self employed people, life gets complicated come tax time. Digging around for the paperwork to fill out tax forms practically qualify as exercise. Such business people have a nightmare trying to find receipts, which is why you should keep track of expenses and receipts year round rather than pursuing a paper chase as April 15th nears.
Remember when you can’t find receipts, you can’t write off your expenses and therefore you are paying more money to the government instead of keeping it for yourself.
Here are seven don’ts—or deadly sins for freelancers at tax time.
- Not knowing what they owe. There are 20 different 1099 forms that get sent out to workers to track freelance gigs. One of them is the 1099-K, which only has to be sent to you by a company in paper form if you make over $20,000. People think, “Great, no paper form, no taxes on that.” But that’s a big mistake—you still have to self-report the income.
- 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.
- 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 to maximizing your tax savings.
- 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.
- 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.
- Employee AND employer. Freelancers 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.
- 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
It is a statistical fact: Self-employed individuals are much more likely to get audited than regular employees. 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 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.
Your calendar will undoubtedly be scrutinized to make sure there are no glaring gaps between possible work, vehicle or equipment usage and the income reported. If you are claiming 100% business vehicle usage, but your calendars do not confirm the times and locations of service stops, you may be open to an analysis of possible personal use of the vehicle. Entries in a business diary or calendar help to justify an expense to an auditor as long as it appears to be reasonable.
Business credit cards are also highly scrutinized as they have a high potential for misuse (such as use for a personal vacation or personal expenses). Keep these only for legitimate business expenditures (places where company checks won’t do). Too many times a small business owner says that they will “reimburse the business later” for that personal expense put on the business card. That routine just opens you up for closer inspection.
Don’t Take the Chance and Lose Everything You Have Worked For
Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important that you’ve hired the best lawyer for your particular situation.
Author: Jeffrey Kahn is a Board Certified Tax Attorney admitted to the California and Florida Bars. He is also a Florida CPA and has an LL.M.(Tax) degree. He is the principal of the Law Offices of Jeffrey B. Kahn, P.C. with locations throughout California including Los Angeles, Newport Beach, San Diego, San Jose, and San Francisco.
Published: April 7, 2015
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