There are a lot of perks that come with being a contract worker. There’s often not a ceiling on the income that you can generate. It comes with many downsides, too, though. Having to address tax matters is one of them.
Your self-employment seldom comes with an operations manual. You must undergo a steep learning curve to determine how to handle your taxes. Unintended consequences could result from not meeting your obligations. This could lead to an audit and owing significant amounts in back taxes. This is, perhaps, the biggest mistake contract workers make when handling their own taxes.
Audits of self-employed individuals
Self-employed individuals and freelancers are three times more likely to face a tax audit than salaried employees.
While some audits are random, the Internal Revenue Service (IRS) closely monitors tax returns of self-employed individuals. Certain factors are more apt to get their attention than others.
Individuals running cash-based businesses
Self-employed individuals who mostly receive cash payments, such as barbershop or flea market owners, are of particular interest to the IRS. You should maintain copious notes about financial transactions in addition to receipts and statements in case an audit occurs years down the road.
Fluctuations in income
Freelancers who experience significant shifts in income between the first year they go into business and subsequent ones are more likely to trigger an audit. So, too, are lower or higher income earners. Someone earning $100,000 is six to eight times more likely to face an audit than anyone else.
High deductions
Taking sizable deductions or ones that don’t seem to be particularly associated with your line of work may lead the IRS to audit you. One example is if you take a 100% deduction for your vehicle.
Underreporting income
The IRS also tends to audit individuals they suspect of underreporting income. Self-employed individuals who use round numbers when reporting income on their tax returns tend to raise red flags.
What should you do if you’re facing an audit?
It can be scary to receive a letter from the IRS warning you of an impending audit. You may assume that you’ll have to owe significant back taxes and fines, and that you’re going to prison. You must build a defense strategy to respond to such charges. An attorney with experience in working out alternate arrangements with the IRS will know the options available to you in such a situation.