The Internet makes it easier to go into business for yourself. That makes it harder to do your taxes.
Armies of independent contractors provide the merchandise on EBay and Etsy and the rides on Uber and Lyft. The number of U.S. businesses with no employees other than the owner is up 29 percent in the past decade, the Census Bureau estimates.
But a dollar earned as a freelancer doesn't go as far as a dollar in a paycheck. At your full-time salaried job, your employer withholds taxes and reimburses expenses. (As an employee, you can deduct only non-reimbursable expenses that exceed 2 percent of your annual gross income.)
An Uber driver must pay for fuel, insurance, car washes, and repairs. An Etsy or EBay seller must buy supplies, inventory, and shipping. Meanwhile, these workers owe a self-employment tax of 15.3 percent, to cover Social Security and Medicare, as well as income tax. Those costs can easily eat up their entire revenue.
To make sure you actually turn a profit, and turn it safely:
Take the deductions
Here's the bottom line, according to Mike Campbell, tax partner at BDO USA: “If you're using something for business purposes, you should be able to deduct it.” Many of the IRS guidelines are common sense.
Accountants say small-business owners are often too timid about taking deductions, rather than the opposite impulse you'd expect. The IRS will never proactively tell you about a deduction you're missing. It also has a record of being lenient with freelancers who make honest mistakes.
Watch the red flags
The IRS does not take kindly to people who hide income. When Uber or PayPal sends you a 1099 form reporting your revenue, the taxman gets a copy, too. It might take a few years, but eventually the IRS should notice if you're not reporting that money.
The agency also tends to notice if your expenses are higher than your revenue. If you're losing money every year, it may limit your deductions by determining that your work qualifies as a “hobby” rather than a business.
Finally, recreation, travel, and entertainment expenses can draw notice at the IRS. You can't deduct lavish cruises and fancy tours just by calling yourself a “home travel agent,” warns Bernard Kamoroff, an accountant and the author of Write It Off! Deduct It! The A-to-Z Guide to Tax Deductions for Home-Based Businesses. The same goes for meals: If you take a client out for a $275 lunch, it had better have a documented business purpose. Even if it does, you can deduct only half the cost of the meal.
Keep track
If you're audited, you'll need to prove your expenses are real. The IRS isn't picky about what form that proof comes in. Apps, spreadsheets, or paper will do the job. Devoting a bank account or credit card exclusively to the business helps keep personal and business expenses separate.
But it's best when you're logging your expenses in real time—as you're spending the money or driving the miles. You won't reliably remember expenses from last year, and the IRS knows that.
And keep all records for several years, says accountant Maggie Mayer. The IRS can take a few years to audit you. If you were deducting a large home office and then later moved away, you'll need photos or other proof that it existed.
Consider the standard deduction
People who travel for work—that includes Uber and Lyft drivers, but also Etsy sellers out picking up supplies—can cover their driving expenses with a standard deduction of 56 cents per mile. Or they can keep track of every oil change and gas fill-up and deduct those expenses individually.
Those with a home office have the same choice. A simplified home office deduction of up to $1,500 is available as long as you devote some portion of your home—an office or even a part of a room—exclusively to business activity. Or you can figure out what percentage of your home the office is and apply that percentage to utilities and rent.
Think retirement
Even if you have a retirement plan at work, your personal business gives you a chance to take out another one. All contributions to a SEP-IRA, or Simplified Employee Pension Individual Retirement Arrangement, are tax-deductible.
Take it to the next level
Keeping track of your mileage or taking the home office deduction is relatively easy stuff. But many rules are complicated, and professional advice may be worth the cost. Businesses can be organized in a variety of ways, including LLCs and S Corporations, which can result in widely different tax bills. Businesses can also take advantage of some surprising loopholes: For example, depreciation rules may make an expensive SUV a better deal than a cheap compact car.
