SELF EMPLOYMENT TAX PLANNING

• Be prepared to explain your style of living
  The IRS knows that it takes time to build a growing business. The IRS also knows that some people fraudulently under report their income. If the circumstances of your enterprise dictate that you report low income or even a loss, be prepared to answer the questions “What did you live on?” If you are unable to answer to the satisfaction of an IRS examining officer, you may find yourself involved in a costly investigation or be assessed with a heavy tax.
  
  Cost of living for an individual is derived from one or more of the following sources:
  
  • Current income
  • Borrowing
  • Repayment of money lent to others
  • Gifts and inheritances
  • Support from others
  • Accumulated assets
  (savings accounts, securities, house, car, cash, etc.) The source of assets accumulated before you launched your business may also be questioned
  
  Your accountant will urge you to keep track of business transactions. You should consider equally important the need to keep track of your personal expenses, including the source of funds for payment of living expenses.
  
  
  
• Keep separate bank accounts for business transactions
  This will simplify record keeping. It is inevitable that there will be some cross flow of funds between business and personal accounts. Pay special attention to documenting this flow of funds. Without adequate documentation the IRS will suspect, and may allege, additional taxable business income.



• Have separate credit cards for business transactions
  This too will simplify your record keeping. At times, certain expenditures will be a mixture of business and personal expense.
  
  Your spouse may accompany you on a business trip. To avoid problems, keep a diary keyed to your business credit card use and all cash expenditures for business travel.



• Have separate equipment, etc., for business use
  If the nature of your business requires that you make and receive business calls at home, install a separate telephone for that purpose.
  
  If you drive a significant number of business miles, keep a separate automobile for that purpose or at least a contemporaneous log of business miles driven in any vehicle.
  
  If your business requires that you do substantial work at home, set aside a room or area of your home as an office. Furnish the area exclusively with office furniture, equipment and business materials, and use it exclusively for business purposes.



• Know your tax responsibilities
  Even if you leave the matter of taxes largely to your accountant and bookkeeper, you should take the time and trouble to educate yourself on the subject. The penalties for slipping up on filings are prohibitively high - with both state and federal agencies.
  
  Learn your personal responsibility for income tax, self-employment tax and estimated tax payments. Then be sure to have some understanding of your responsibility in the area of employment taxes. IRS Publication No. 15, and supplements 15A and 15B, commonly known as Circular E (Employer’s Tax Guide), is available free of charge from the IRS. You can download this form from the website, www.irs.gov. You should also be aware of state and local tax requirements.
  
  In the past, some employers used government trust funds (taxes withheld from employees’ wages) to tide the company over periods of weak cash flow. Be advised that the IRS has little patience with such methods. It has an unflinching policy of cracking down fast and forcefully on employers who do not follow the letter of the law in handling withheld payroll taxes. If you are in a pinch, ask your accountant to locate an alternate source of funds.



• Keep good records
  Your accountant has primary responsibility to provide you with a system that clearly and properly reflects your business income and transactions. A simple method of record keeping that works is one that is organized to reflect tax return items line by line.
  
  If you are a sole proprietorship, you can set up your accounts according to the line items on Form 1040, Schedule C. Mark your checks, credit-card receipts and diary entries with the appropriate type of expense or line number.
  
  For more complex and/or active business enterprises, you would be wise to rely on the expertise of a reputable accountant familiar with your type of business. Expect your accountant to set up a record keeping system, give business advice and represent you at the IRS if necessary. It will be money well spent.