Believe it or not, when you're self-employed, the IRS can be your friend (well, sort of). For those outside the United States, the IRS (Internal Revenue Service) is the federal-level tax authority in the USA. Depending on where you live, you may also be subject to the authority of state, county, and city level tax agencies, but let's focus on the big dog. One of the most common mistakes that newly self-employed people make is that they fail to set aside money to pay their taxes. Come April 15th (tax day) they are in for a rude awakening. There's nothing quite like the feeling of filling out the tax forms and discovering that you owe multiple thousands of dollars, and you don't have it.
When you were a W-2er (a.k.a. employee... W-2 is the IRS form your employer used to report your income and taxes withheld) your employer would take out (withhold) a portion of your income to pay your income tax and other taxes throughout the year. This was taken out before you even got your paycheck, and you didn't have much say in the matter. Oh sure there were a couple different ways you could increase or decrease the amount that was withheld, but it was always something. But, now you're a 1099er (your clients will use IRS Form 1099-Misc to report the payments they made to you and show they did not, and were not supposed to, withhold anything for taxes). As a 1099er, YOU are responsible for setting aside money to pay all those taxes. And most people don't do it (at least not until they've faced their first April 15th). So train yourself to set aside a portion for taxes. Take a look at last year's tax form and see how much of your gross income you paid in taxes, and then each time you get paid, set aside a comparable percentage. This takes discipline, but after your first heart-stopping April 15th, it becomes easy.
OK, so how can the IRS be your friend? Well, the tax laws in this country are written in favor of business. (And that is as it should be, because business is the engine in our economy. Keep the engine healthy and strong, and the whole nation benefits.) The way that the tax laws benefit business is that a business owner can deduct certain expenses from their taxable income to reduce their tax liability. I am not an accountant and so I won't make any specific recommendations. But let me say this: I am willing to pay taxes to support the government that gives me the right to be in business for myself and make a profit; but I don't want to pay them any more than I have to.
One other thing to be aware of with the IRS is that they can declare that, contrary to what you told them, you really were a W-2er and not a 1099er, and your deductions are disallowed, and the company owes back-taxes as well as fines and penalties. But you can reduce the chances of this nightmare occurring by the careful wording that your lawyer (which you got after reading my Self-Employment 101 post) put into the written contract for the work you have performed.
Take all the tax deductions that you are legally entitled to. But don't get greedy and stupid and break the laws. After all, another thing you need in business is integrity.
posted @ Monday, November 24, 2003 12:18 AM