5 Things I Wish I Had Known About Freelance Taxes: Part 5
I think a tax audit would be one of the worst things to happen to a freelancer. It would be expensive in both time and money, and would likely leave one bitter and less productive. So how does it happen and how can I avoid it?
There is no magic to it. Computers churn over the tax returns at the secret IRS tower of doom, spitting out the ones that seems suspicious. The program bases the suspicion factor on how your tax return stacks up against the other ones in your tax bracket. There is a secret algorithm that they have set up to automatically select the ones that will most likely bring in audit revenue. Yeah, that makes it sound slimy. But, we’re all out to make money here, including the IRS. The good news is, getting audited is statistically rare. According to a must-read CNN money article, only 0.57 percent of all filers get audited.
Collected from the wisdom of my tax preparer and the internet, here’s what I wish I knew when I started freelancing:
Self-Employment
What? Yes. Because you are self-employed, that puts you into a class of people more likely to be audited. Self-employed people are more tempted to deduct things that aren’t totally legal. Their income is varied, can be in cash, and their business expenses often dubious. They claim business expenses like home offices.
Too many itemized deductions
While you want to deduct everything possible, your deductions have to match up with the averages of other folks like you in your area and tax bracket. You don’t want to go over the top. The trick is to keep it sensible and record everything. The IRS loves a paper trail, and meticulous records help them know that you are a careful, honest person.
Cash income
Taxi Drivers and waiters/servers are examples. The IRS knows that cash is easy to leave out of the income reporting, and more difficult to track. They have statistics that demonstrate this.
Uneven or unsteady income
Another facet of self-employment. This is inevitable, since we freelancers are not in salaried positions. For example: I get paid on the whims of my clients, so I go through very uneven pay periods.
Large or un-ordinary expenses
Did you have a large, un-ordinary expense? If it stands out and is rather large and uncommon, then look out. Like a rodent, you just poked your head out of the burrow and are attracting unwanted attention. For instance: As a web designer, I could never claim the purchase of an automobile. If these are something you have to do and are legitimate, pay with checks, get receipts, and leave a paper trail.
Accuracy
This seems obvious. While mistakes are common, less of them is less opportunity for the IRS computer to notice your return. Mistakes in and of themselves are not audit triggers, but enough of them and you’ll get noticed.
Claiming a portion of one’s home
As unfortunate as this is, This is a biggie. Remember, your home office needs to be used 100% for exclusive business and limited to a reasonable portion of your home. If you claim your living room, it’ll stand out as odd and you’ll raise a red flag.
This blog post is not intended to be specific tax advice. For tax advice, go consult a professional.
Read the other posts in this 5-part series:
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