Self-Employed Taxes: How to Handle the IRS on Your Own

NEW YORK (MainStreet) — Growing numbers of Americans are now self-employed. In fact, Quartz recently reported that by the year 2020, as many as 40 percent of American workers will be freelancing. If you received a 1099-MISC form this year, you're going to have to file as a freelancer, at least in part. If this is your first time doing so, you might be in for a big sticker shock.

But before you panic, know that there are some things you can do to ease the pain. You can't retrace your steps from last year, but you can mitigate some of the damage as well as prepare for next year.

It's Never Too Late

"The process needs to start last year," says Janet Lee Krochman, a self-employed CPA, who says that every year people show up and hear all the stuff they should have been doing... right before their eyes glaze over. "If you haven't been collecting the data over the last year, you're going to wish that you had."

The solution going forward? Krochman recommends getting QuickBooks or something like it to keep track of your self-employment finances over the year. "The basic version, QuickBooks Essentials, can produce a report with everything that you need based on information you input over the course of the year," she says.

For last year, however, you're just going to have to start digging around in receipts and bank records looking for deductible items.

Save or Expect to Pay Big

"People think 1099s are just like W-2s except they didn't have anything withheld," says Bradford L. Hall, managing director of Hall & Company CPAs in Irvine, Calif. "You also owe Social Security and Medicare tax that you probably haven't thought about." He cites this as the biggest mistake that people make when setting up a business -- to the tune of 15.3%.

The standard for self-employed, sole proprietors to put aside from every check they receive is 30%. That's going to work just fine until you start getting into higher tax brackets. You might get a refund and you might owe, but you're not going to be in way over your head like you will be if you failed to save anything.

The Truth About Audit Risks

One of the biggest concerns that people filing for the first time have is getting audited, with the home office being one of the places where first-time filers tread lightly. While Hall does state that the audit risks are higher for sole proprietors than LLCs, partnerships, S Corps and C Corps (four to ten times more likely, he tells us), less than 1% of all returns are audited and 70% of those are handled through the mail.

What's more, your Schedule C has a lot to do with your audit risk. "Schedule Cs with a gross income over $400,000 have a much higher audit risk," explains Hall. "That doesn't mean making $399,000 will keep you off," he says, going on to state that every deduction category has an audit trigger associated with it.

Of course, the best way to cover yourself in the event of an audit is to report all of your income and to never claim anything that you can't prove. Remember that if you filled out a W-9 form and received a 1099-MISC in the mail, the IRS knows that you got the income. Not reporting it is just inviting trouble.

"Section 162 is the Basic Code section that determines deduction availability," says Krochman, who advises the self-employed to become familiar with it. Like most pertinent tax information for the self-employed, this information can be found online at the IRS website.

So What Can I Deduct?

There's all kinds of stuff you can deduct. Basically anything that you bought or paid for with the express purpose of using for your business. If you work from home and have a room in your house exclusively dedicated to that, you can even deduct part of your rent and utilities.

This underscores the purpose of keeping records throughout the year: You might not be able to remember everything that you purchased throughout the year in April, but you can certainly keep track of everything that you purchased as you pay.

--Written by Nicholas Pell for MainStreet

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