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How the Self-Employed Can Avoid a Dreaded Tax Audit
Ask Don Linton about the self-employed and taxes, and he'll offer a familiar image: A client arrives at his office with a paper bag full of crumpled receipts. It's the kind of story that Linton, a Certified Public Accountant in Maryland, says is all-too-common around tax season.


"It can be a whole new world for many people who have never worried about paying taxes because it was done through their employer," Linton said.

There are, however, some basic rules that can help the self-employed save money, avoid headaches and avoid raising the ire of the IRS.

First, Linton says, remember that Uncle Sam doesn't regard just anyone as self-employed. As a general rule, accountants say those who have earned more than $400 in income that was not subject to withholding taxes, normally qualify.

The next step is figuring out what can be deducted to lower the total tax bill.

Here's where tax experts say many self-employed people can save thousands of dollars through simple steps that include knowing what counts as a deduction, good record keeping and planning ahead.

Expert Tip
Invest in a tax-deferred savings retirement plan, such as a Simplified Employee Pension (SEP-IRA), or a SIMPLE IRA.

Simply put, deductions are anything used to do business. Sound broad? It is, but experts say the self-employed are entitled to deduct everything from the cost of renting an office space to phone expenses and even magazine subscriptions, as long as it is used as part of their business.

"You can ask yourself two questions: Does this directly impact my business?," said Kevin Coleman, a Los Angeles-based CPA. "And secondly, is there any personal use involved with this expense?"

So for example, those who want to write off the cost of their cellular phone as a business related deduction must make sure they use it primarily for business.

"It is reasonable to take a 100 percent deduction on that cell phone if you spend 85 percent of the time you use it making business calls," Coleman said.

The key is not getting carried away and claiming everything as a business expense.

Expert Tip
Investigate what taxes you are expected to pay. Being self-employed doesn't get you off the hook from paying other types of taxes. For example if you hire an employee part-time, you still may be expected to pay an employment tax.

Perhaps one of the most confusing situations arises for people who work from home. The good news is they are entitled to deduct part of their rent or mortgage. For example, freelance journalists who turn a spare bedroom, or even part of a room into an office can deduct a portion of their rent or mortgage as a business-related expense.

Again, the important thing to prove is that it is the primary place of business.

Moreover, thanks to a change in the in the tax law, more self-employed people can take advantage of the home office deduction.

Independent contractors, computer consultants and even doctors can deduct part of their rent, as long as it is used for administrative or management activities and there is no other fixed location, such as an office, used for the same purpose.

The self-employed also shouldn't forget to include other business-related expenses, such as professional dues, seminars, and transportation costs. (Yes, they can get a tax break for driving all over town to meet clients.) Even the cost of going out to dinner is considered a business expense and therefore a deduction.

In addition, a recent change in the tax law now allows the self-employed to claim up to $19,000 for equipment costs, instead of deducting only a fraction of that amount over time.

"The first thing I tell my clients is go out an buy something," Linton said.

But don't expect to claim those deductions without some kind of receipt.

Those in business for themselves must prove their expenses and income, because trying to deduct a $200 meal at a trendy, French bistro without a receipt could land them in the middle of an audit.

Expert Tip
Hire your kids. If your children are under 18, hire them and get a tax break. Children are allowed to earn up to $3,000 a year without having to pay taxes, and you can deduct their salaries without having to pay any employer taxes.

"The important thing is whatever you do keep all your checks and receipts," Linton said. "Keep all your lunch tickets. Keep a diary or something that indicates how this expense was business related, the cost and when you paid for it, even if it's just a Visa card receipt."

The key is to maintain simple, but accurate records in case the IRS has questions.

"If you do a nice job if you are ever audited or have your tax return questioned you won't have a problem," Linton said. "But if you just have a bag full of crushed receipts and make the (IRS) agent work hard, don't expect the agent will be very nice to you."

In addition, he suggests keeping those records for five years in case the IRS decides to audit.

And lastly, remember to pay quarterly taxes. Linton and Coleman both urge the self-employed not to wait until the last minute.

The self-employed are required to make quarterly tax payments up front. Those who forget will pay a hefty interest rate, Linton said, adding that Uncle Sam will charge the prevailing rate.

Both Linton and Coleman say consulting a tax expert is helpful even for those who plan to prepare their returns themselves because a professional can help navigate through confusing tax forms, answer tough questions and even rescue those who might pay too much.

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