If you earned income as a self-employed person, single proprietor, independent contractor, or LLC sole owner, you will get an IRS 1099 Form for that reason. You work for yourself if you own a sole proprietorship, whereas small business owners who operate LLCs, partnerships, or corporations may employ both workers and independent contractors.
There are certain filing requirements for self-employed people throughout tax season. Along with federal income tax and state tax, you must also pay self-employment tax (SE tax) (if applicable). A self-employment tax (SE tax) is a levy on Social Security and Medicare paid by independent contractors. If you work for an employer, your employer will deduct half of the Social Security and Medicare taxes (7.65%) from your pay and you will be responsible for the remaining 7.65%.
You are responsible for the full tax amount, as you do not have an employer. You pay the full 15.3% tax as a self-employed person and write off 7.65% as a business cost. If you work for yourself, you must keep track of your own revenue rather than having it handled by a company’s payroll system. You could consequently make accidental errors on your taxes. Take a close look at these seven common mistakes that many people make on 1099s, as well as these four tax advices, if you want to keep more of your hard-earned money.
Table of Content
- 1 7 Mistakes to Avoid in an Audit
- 2 4 Tips to Avoid in an Audit
- 3 Taking Everything into Account
- 4 Conclusion
- 5 Frequently Asked Questions
7 Mistakes to Avoid in an Audit
1. Misunderstanding Form 1099
There are various 1099s available, and each has unique tax-reporting requirements-. For distributions from pensions, annuities, retirement, profit-sharing plans, IRAs, insurance policies, etc., you can receive Form 1099-R. Or, if you got sales profits from a real estate transaction, you might get a Form 1099-S.
You must still self-report the income on your taxes if you are self-employed (full- or part-time) and you earned money but didn’t receive a paper form, perhaps because it was misplaced in the mail or the wrong address was supplied. The failure to record the income could result in an audit and the payment of past taxes, interest, and penalties.
You must submit an income tax return if your self-employment income was $400 or more. If you made more money from another source and your total income was less than $400, you might still be required to file an income tax return. Contract work offers more flexibility, but it also carries more responsibility. Make careful to educate yourself on Form 1099 if you are new to the world of contract work.
1040 vs. 1099
The differences between forms 1040 and 1099 are frequently unclear. The simplest explanation is given here. The individual income tax form, known as Form 1040, is used by both employees and independent contractors. 1040 must be filled out and submitted annually by the tax deadline. However, if you have been paid as a self-employed person, you will receive a form called 1099. Any client who paid you $600 or more for your services during the tax year needs to send you a 1099.
You should still declare your self-employment income even if you didn’t earn more than $600 and didn’t get a 1099. Forms 1099 must be sent by businesses on or before January 31 of each year for the previous calendar year. But the Internal Revenue Service advises getting in touch with them if you expect to receive a 1099 and don’t by February 15. You might be able to file your return using a substitute form or online.
2. Not Writing off all Business Expenses
One benefit of being a self-employed contractor is that there is a little more leniency in what qualifies as a business cost. For example, a company might pay an employee or an independent contractor for similar work, but as an employee, you normally aren’t allowed to deduct your travel expenses. On the other hand, if you’re self-employed and you work largely from the home office, you can deduct your mileage whenever you spend time traveling to and from a client’s office. If you use local transportation, you can deduct any public transportation costs as well as the business portion of your actual car expenses, such as gas, insurance, registration, repairs, and maintenance.
Most business equipment with a useful life of more than a year and that you actually use in your business for more than a year can also be depreciated. Computers, furnishings, and equipment may be included. Using Form 4562, you can deduct an expense for depreciation. The simplest way to keep more of your hard-earned money as a self-employed contractor is to claim all of your business costs. If you don’t, you are overpaying taxes by hundreds or even thousands of dollars annually.
3. Writing off Personal Expenses
It’s common knowledge that expenses that are obviously personal cannot be deducted. It is not always clear what counts as a personal expense or a business expense. You cannot deduct the entire cell phone charger, for example, if you use your phone for both personal and professional purposes. Instead, you must prove predominant business use, which requires that you use your phone for work-related activities more than 50% of the time.
The same restrictions apply to your computer and transportation, so you can only deduct the percentage that is used only for work. In other words, unless your computer is used primarily for work, consider twice before deducting the entire cost of your computer.
To avoid raising any concerns with the IRS, writing off partially personal expenses will take some research and good record-keeping on your part. Only the percentage of your personal property that is used only for business purposes should be deducted from your taxes. Just make sure you have a good cause for deducting 80% of that cell phone bill before approaching the IRS.
4. Writing off Mileage and Car Expenses
It is possible that you will sometimes need to use your car for work if you are self-employed. Although the deduction for miles driven is likely the largest, there are two other ways to deduct a portion of the wear and tear on your car from business use.
- The Actual Vehicle Expenses Method: Using actual vehicle expenses Start by totaling all of the costs associated with operating your car, such as gas, insurance, interest on your loan or lease, repairs, maintenance, and so on. Then you have to divide all miles travelled by any miles just used for business. Your allowable deduction is equal to that proportion.
- The Streamlined Approach: Total the number of miles you drove for business throughout the year, using the IRS-mandated mileage rate. The normal mileage deduction for business use is now 58 cents per mile for the 2019 tax year, up from 54.5 cents in 2018.
Whichever method you go with, you must record all business-related mileage in a vehicle log. You can do this by simply writing down the miles, dates, and descriptions in a notebook, or you can track your mileage accurately by using software like QuickBooks Self-Employed.
5. Not Keeping Adequate or Accurate Records
Even if you have done a great job writing off all of your allowable company expenses on your taxes, if you haven’t kept adequate records, it will all be for nothing. You must maintain a record of all company receipts for the IRS to verify that you paid for all claimed expenses. Yes, it requires some planning and time on your behalf, but the results will be worthwhile. Lack of organization is one of the biggest causes of errors when it comes to 1099 revenue, and those errors may result in extra tax payments and penalty fees.
6. Paying Quarterly Taxes
Federal income taxes are often paid by the self-employed on a quarterly basis by a set due date. If your company is not deducting taxes from your salary, it is your responsibility to pay estimated taxes four times a year at the conclusion of each fiscal quarter. April 15, June 17, September 16, and January 15 of the following year are the deadlines.
In general, you are free from quarterly tax payments if you expect to have an annual tax bill of less than $1,000 after deducting federal income tax. Additionally, if you have federal tax withholdings (perhaps because one of the businesses you contract with deducts taxes or because you receive W-2 income), you might not need to file quarterly tax returns if your withholdings total 90% or more of your annual tax liability. However, if you expect owing $1,000 or more in taxes when you submit your return, you are in charge of making quarterly payments.
7. Penalties for Late or Non-Payment
Nobody enjoys paying taxes. The IRS may still fine you if you don’t file quarterly taxes, though. The non-payment penalty can be as much as 5% for each month that the payment is past due, but it can never be more than 25% of the entire amount owed.
Payments over 60 days overdue will incur a $100 penalty from the IRS. Estimated tax underpayment is also subject to penalties. The good news is that QuickBooks Self-Employed can handle your deductions and calculate your quarterly tax payments.
4 Tips to Avoid in an Audit
Mistakes may result in hefty fines and/or an IRS audit. And even if you make an effort to avoid common mistakes, you can still be subject to an audit. The truth is that everyone has a risk of being chosen for an audit since the IRS uses your taxpayer identification number and mathematical formulas to select individuals from all groups. The IRS uses it as a tool to maintain accountability.
Consider the following: If the IRS only looked at individuals who earned more than $5,000 in net earnings, some taxpayers may change their books to appear as though they earned less than $5,000. Everyone is therefore eligible for an audit, regardless of their income. There are some actions you can do to reduce the likelihood of an audit. Here are four suggestions for keeping your taxes in order and the IRS off your back.
1. Make sure Your Tax Records and Reported Income are Accurate
When the year is over, representatives receive a Form W-2, whereas contractors for hire receive a 1099-MISC structure. The two forms add up your pay, and copies are sent to the IRS so they can also see how much you earned that year. Since these forms are attached to your Social Security number, their system will consequently get any inconsistencies, which will increase your risk of an audit.
So, if the form you receive doesn’t match the amount you were paid out, follow the below steps:
- Verify that you didn’t make a mistake. Commissions and other fees might be included in your gross compensation on a 1099-K. You can deduct these as a business cost, so your taxable income and tax brackets aren’t affected by the fees.
- To request a reissue, get in touch with the business that recruited you as a self-employed contractor. Check to see if you are receiving non-employee compensation. It’s best to get in touch with the company as soon as you can to resolve the issue because occasionally businesses will make mistakes on your 1099.
2. Carefully Document any Commonly Audited Expenses
Because people frequently take advantage of the system or make mistakes, the IRS will audit some income and expenses more frequently than others. For self-employed contractors, a few common places that signal the alert are:
- Car Expenses: Make sure all mileage you deduct is for business purposes alone and has been properly noted in a logbook or via a mileage tracker.
- Home office Expenses: You must use the area of your house that you specify as a home office regularly and exclusively for business purposes. The IRS closely examines the home office expenditure deduction.
- Meal Expenses: Make sure the meals were either with a customer and had a business purpose, or were incurred when traveling overnight on a business trip.
3. Do not Assert that a Hobby is a Business
If you incur a business loss for three out of five consecutive years, the IRS might call you up, saying that you’re pursuing a hobby and not actually running a business. You will have to prove that you genuinely intended to turn a profit and give details as to why you didn’t. If the IRS thinks your business is simply a hobby, they might reject any business expenses you have previously written off, meaning you could be on the hook for back taxes and fines.
4. Don’t Call Attention to Your Income
In similar situations, the IRS commonly compares your income to others. If you only declare $5,000 in income but live in a wealthy zip code or if you made a lot of money the previous year and no money this year that will also enhance your likelihood of an audit.
Taking Everything into Account
Use these seven guidelines to understand 1099 in its entirety. Keep your expenses and receipts organized so you can claim the maximum number of deductions you are entitled to as a self-employed worker. This will ensure that you are prepared when tax time comes around. In order to avoid an unnecessary audit, make sure to pay your quarterly taxes on time and accurately, as well as avoid making typical tax mistakes.
In case you are audited, you will be better prepared to help make it a smooth process for everyone.
With the help of the above article, your doubts related to the 1099 form: 7 mistakes to avoid and 4 tips to prevent an audit are cleared. You will get all the information in easy steps in this article. In case you are still confused then you can call the help desk. The Dancing Numbers team is available round the clock for their users to help their users.
Frequently Asked Questions
How to Exclude an Amount From the 1099?
Create a journal entry for the vendor that offsets the nonreportable amount if the amount of reportable payments for a 1099 vendor exceeds the IRS reporting threshold amount. With the last day of the tax year date the journal entry.
What Triggers a 1099 Audit?
Make careful to declare all of your income, including any from investments or gambling, to the IRS. An IRS Audit may be prompted by cash-based businesses, sizable overseas holdings, and sizable cash deposits, among other reasons.
What is not a 1099 Reportable?
Except for payments for attorney fees and medical or healthcare services, payments to companies do not need to be reported on Form 1099 MISC. Payments made to non-employees are disclosed in Box 7 of Form 1099 MISC.