“The self-employed person can’t just go to the end of the year and say here’s how much I owe. You are required by law to make payments during the year.” — Don Roberts
Some of my favorite clients — the self-employed — are looking to settle up with the government for 2016 and, the very, very good ones, are filing their quarterly taxes for this tax year.
As the shoemaker’s children have no shoes, I am not usually one of them as I am engaged in working with you fine folk to get you out from behind and into the light.
The self-employed are people who own and operate their own businesses – incorporated, formed as a Limited Liability Company (LLC) or not – and are involved in its daily operations. It’s not always the same as a general business owner, who may not be involved in the daily operations. An example would be Jane Smith, the owner of the Jane Smith Law Firm. Ms. Smith is the sole employee of her firm and does not have taxes withheld from income by an employer, so she is responsible for her own estimated income tax and self-employment tax.
Let’s review a few tips Ms. Smith should know before she files her quarterly taxes.
Avoidance v. Evasion
There is a difference between avoiding taxes and evading them. Avoiding a tax is something individuals and business owners all aim to accomplish. As the entertainer Arthur Godfrey said: “I am proud to be paying taxes in the United States. The only thing is – I could be just as proud for half the money.” The business owner is obligated to pay taxes, just not more than his or her fair share and as long as they do it within the limits of the law. Depending on the form of business, business owners are susceptible to double taxation because owners who pay themselves with company profits must pay taxes on their individual returns. In an effort to legally avoid this double taxation, Jane Smith should change her law firm’s structure to an S-Corporation or LLC.
Evading taxes is illegal if Jane Smith lies, cheats, or somehow falsifies information. Jane will likely not look good nor enjoy wearing orange. That’s the price of evasion: severe penalty and possible wardrobe change.
Your Audit Lottery Odds Increase
The IRS has a fondness for auditing the self-employed over the standard W-2 laborer. Jane Smith reports only to herself and doesn’t need to pay anyone. That means no one in her company oversees her hours or expenses…except ultimately the IRS. For example, Jane will need to prove that she “needed” a $10,000 cocobolo desk to attract clients and operate her business. The IRS may disagree and she may incur a penalty. A typical W-2 employee is issued a workspace by an employer and in most cases cannot expense it. The IRS may audit the employee’s company, but typically not the employee unless there are major red flags.
Some Notes For The Newly Self-Employed
To any reader or visitor who has changed their filing status to “self-employed” in the last year, good luck and g-dspeed. It’s a tough leap to make. I’ll bet some of you already miss the direct deposits, free coffee and once-a-year filings. Keep moving forward and after a while, you’ll know if this was the right choice for you.
In the meanwhile, keep all your receipts; this includes meals, travel, software upgrades and anything you spent money on that somehow benefited the business. This leads to paperwork, which we at Brinen & Associates love as much as our self-employed clients.
Contact us to discuss your tax filing needs.