Everyone’s favorite time of the year, tax season, is right around the corner, so we decided to phone a friend and get some insights from a seasoned tax professional on how to make the most out of filing your taxes.
Q: What’s the biggest mistake you see contractors make when filing taxes?
A: It seems that they don’t keep track of their expenses adequately. Right from the start, I would suggest that they document all their expenditures. The IRS likes independent confirmation of amounts spent, i.e. receipts. Trying to guess at business miles driven, meal expenses, travel amounts when it is time to do taxes is NOT a good idea. In this age of technology, I would advise clients to perhaps scan and save their paper receipts if they don’t like hanging on to the physical paper (Editor Note: many banks can make tracking expenses a breeze, including our banking partner Lili). This way, everything is ready at tax time, and should they have to justify anything to an IRS agent 2-3 years after the expense was incurred, it will be a lot easier.
Q. What advice do you have for someone who’s recently switched from the W-2 to 1099 world?
A: They need to understand that they must keep track of things themselves. As an employee, their employer is responsible for keeping track of income and withholdings. As an independent contractor, they must track all income and expenses themselves. It pays to spend the time investigating methods of doing that. Whether it’s reading articles or paying an accountant to advise on what is or is not taxable or deductible, they must realize that the responsibility lies fully with them. Many times, people who are new to the independent contractor world don’t realize all the things that are deductible, e.g. home office expenses, vehicle expenses, etc.
Q: What is the best thing an independent contractor can do to make filing taxes easier?
A: Keep current track of income and expenses. I advise clients to make use of a program like Quicken to track their income and expenses throughout the year. It’s an inexpensive and easy-to-learn and easy-to-use program. If they input their information periodically, it makes year-end SO much easier. Further, they get an idea of where they stand during the year. No one likes a surprise!
Q: Who should file with a CPA and who would be okay using software?
A: It really depends on the tax savvy of the individual, as well as their ability to navigate tax software. I have seen and dealt with SO many people who thought they could do it on their own, and it was a huge mess! Having said that, it seems that the person most able to do their own return using tax software is someone who works a single job with virtually nothing else going on in their tax life. Maybe they may have a bank account or two that generate interest income. If they have a more complex situation going on (multiple jobs or investments), then I would recommend hiring a professional. It will pay-off in the long run.
Q: How often do tax codes change, and how can contract workers stay informed about what that means for them?
A: The tax law continues to change. I’ve been doing this for 40 years, and the changes to the law seem to be coming faster all the time. In the last few years, both federal and state law has been changed retroactively, i.e. changes to the 2020 law enacted in 2021! This makes it hard to plan. For contract workers, I would advise them to find someone to help them with their return, especially if they work multiple gigs or have multiple sources of income. There are many nuances, and it’s a lot to keep up with!
Q. What happens if you receive an IRS audit? How can you ensure that doesn’t happen to you?
A. First and foremost, don’t panic! If they are selected for audit, take the time to really read and understand what the IRS is asking for. Often, it is just one or a few items they are questioning. If the taxpayer doesn’t understand or doesn’t want to deal with it, hire a tax professional to help. In either case, they will need to gather their documentation to support the amounts claimed on the return. They should respond to the notice within the time specified. The worst thing they can do is ignore the notice. The IRS simply does NOT go away. Keep responding to notices. Keep copies of everything they submit. Lately, audits seem to be done remotely. This means that the taxpayer’s response will be sent by mail or fax. For a mailed response, send it via certified mail with return receipt requested. For a faxed response, get a copy of the sent transmission. It is crucial to show that they complied with the IRS request, and they have proof that the IRS received it.
Finally, there is no way to ensure you won’t be audited. I have seen many audits where the IRS is in error. Their wires got crossed somehow. Even if the audited amount is not in error, it’s often just a matter of what I like to call drawing them a map showing them exactly how you arrived at the amounts reported on the return.
Additional resources
Need more advice? This article from Smart Asset dives a bit deeper into the different forms and write-offs that may pertain to your tax return. This Forbes piece reminds you of some common deductions for contractors, such as health insurance premiums purchased through healthcare.gov, your business mileage, credit card interest, and home offices. This post from C.E. Thorn, CPA gives great advice for independent contractors’ best practices when it comes to tax preparation. And, if you’re looking for a trusted professional to help with your tax return, check out the ICBA Contractor Advantage Plan.