By this time of year, the self-employed, like other taxpayers, are probably too busy getting ready for this Apr. 15 to think about filing for Apr. 15, 2002. But while your options for trimming your 2000 tax bill have dwindled to a mere handful, you can take a wealth of steps to limit your 2001 liability. It pays to make time now, before too much of the year has elapsed, to get your financial ducks in order. That way, you can avoid common mistakes that lead many self-employed taxpayers to either overpay or lose out in an Internal Revenue Service audit.
As far as your current tax bill goes, you have until Apr. 15 to contribute as much as you're allowed to a tax-deferred retirement savings account for the self-employed, such as a Keogh, a SEP-IRA, or a Simple IRA. And there's still time to comb your business calendar and other records for deductions. Some often-overlooked items include 60% of the premium you paid for health insurance, finance charges on business credit cards, and cell phone and Internet connection fees.
Even as you're getting those last-minute steps done, you should be setting up a manual or computer system to monitor all your expenses and income this year. One accounting program you might use is Intuit's QuickBooks. You should also be making a list of your anticipated business expenditures, particularly large ones, such as new equipment.
This may seem like basic planning for any business, but it's a measure many of the self-employed neglect. And it's particularly crucial because self-employed workers must pay estimated taxes four times a year. So you will begin making payments on your 2001 liability this Apr. 15, the same time that you're paying the remainder of your 2000 tax bill. Moreover, you must have paid by Jan. 15, 2002, an amount equal to 90% of the tax due the coming Apr. 15 or, depending on your income, either 100% or 110% of the tax paid the previous year. Otherwise, you will face a penalty equal to 9% of the tax due. If you keep records up to date as you get new clients or sign new contracts, you can stay on top of what your final tax bill is likely to be.
Failure to accurately predict total income or cash flow can be costly. Mary Lou Pier, a Chicago CPA, says a client told her that "he had made much less money last year. It turned out that he'd earned $85,000 more than the year before, and he had to pay $20,000-plus more tax than he'd expected."
Good tax planning also means realizing that although you need to keep your business and personal-finance records separate, the two parts of your life intersect at tax time. Married couples especially need to "integrate the business piece with the tax piece," says Tom Bargsley, an Austin (Tex.) accountant. For example, under a provision called Section 179, the IRS allows businesses to deduct up to $20,000 in 2000 for capital expenses, such as computer equipment and office furniture. (This increases to $24,000 for 2001.) Those limits apply to each tax return, not to each business. So spouses who each own their own business but file jointly are allowed to deduct only $20,000, not $40,000, in 2000.
Another common mistake among self-employed taxpayers is neglecting to learn basic IRS rules. Take the example of a self-employed salesman who phoned Bargsley to discuss last-minute tax issues in December. "I'm not going to pay any taxes this year," the client said, explaining that he had lost $50,000 when he sold a tanking tech stock in his personal portfolio. The salesman's complacency faded when Bargsley explained that the IRS would only allow him to write off $3,000 of the investment loss for 2000, and he would still have to pay the usual income and self-employment or Social Security tax on his business profits.
You also should seek advice before making decisions that could affect your taxes. For example, many people lease cars to use for their business. Peg Eddy, a certified financial planner in San Diego, says that if you can afford it, you might be better off tax-wise to buy the car outright. For example, if you lease a $35,000 sport-utility vehicle for, say, $500 a month, you can deduct $6,000 at the end of the year. If you buy the car, you can take depreciations and business deductions of about $23,000. Because many people are not familiar enough with tax rules to figure this out on their own, they inadvertently lose larger deductions, says Eddy.
Meanwhile, some self-employed taxpayers often decide not to claim legitimate deductions because they fear an audit, tax preparers say. "People tend to worry about things that are listed on the [Schedule C] tax return, such as the home office deduction. They think the IRS will automatically come after them," says David Windish, executive editor for Tax Analysts, a tax information publisher in Arlington, Va. If you do some work at home, this can be one of your most valuable deductions, he says. The IRS has relaxed the rules in recent years so that many more people qualify. For instance, effective in 1999, the definition of "principal place of business" was broadened to allow the home-office deduction even if you use the office only for administrative tasks, such as billing, bookkeeping, and making appointments.
WHERE YOU WENT. While most workers know that sloppy record-keeping can cause them to lose deductions, many don't realize that receipts aren't the only way to document an expense. Just because you don't have a receipt doesn't mean you can't take a deduction, says Gene Fairbrother, a small-business consultant in Dallas who advises members of the National Association for the Self-Employed on taxes. If you don't have a receipt for a business lunch, say, you may be able to document the expense with a credit-card statement or by noting the location and business purpose of the meal in your appointment calendar. If you didn't record your mileage for each business trip in your car, use your calendar to substantiate where you went on business that day.
Of course, you can push deductions beyond reasonable limits. That's why you need to take the time to be conversant with IRS rules. No matter how small your business might be, a tax plan should be part of your business plan.