This is especially true if you are one of the 21.5 million Americans who file as sole proprietors or self-employed taxpayers.
Pursuing your entrepreneurial dreams has drawbacks at tax time -- including extra forms, estimated tax payments and a higher tax rate (on top of federal and state taxes, and the normal Medicare and Social Security contributions, self-employed taxpayers get hit with an additional 7.65% tax). But sole proprietors are also eligible for a number of deductions that aren't available to regular employees.
Need a little help to wade through the red tape? Here are some guidelines:
Look for Help
If this is your first time filing as a self-employed taxpayer, you might not want to tackle it alone. "If you have a significant change in your tax situation, it might be a good idea to hire a professional," says Keith Hall, a CPA and tax expert with the National Association of the Self Employed. "You can then use your 2007 return as a template for what forms to fill out and what deductions to look for on future returns."
At the very least, use online tax software such as TurboTax or TaxACT 2007. "Math errors are the number one reason that people get a reply from the IRS," says Hall. "Transposing numbers in a Social Security number or making a mistake when transferring totals from one form to another is easy to do. The software is designed to take care of that, and to check the math."
What You Need
Whether you hire a professional or do it yourself, you'll need to gather the following information:
All of the paperwork documenting your business income: typically sales receipts or, in the case of contract work, 1099-MISCs. (The moment you fill out a Schedule C, for business profit or loss, you increase your likelihood of getting audited. So make sure you have the backup documents.)
Any income you received as an employee, documented on W2s.
Documentation of any other income, such as dividends or interest from investments.
A list of business expenses including travel, equipment purchases, contract expenses and association fees, along with receipts and other documentation needed to support each claim.
Documentation of personal deductions such as mortgage interest payments, health insurance premiums, student loan interest payments and so on.
If you have trouble finding the necessary paperwork, take it as a sign that you need to develop better systems for organizing your 2008 tax records.
Consider an Extension
If April 15 looms and you're not ready, you can e-file for an automatic six-month extension using Form 4868. While the extension gives you time to do your paperwork correctly, it doesn't let you postpone your payment -- you still have to pay the IRS by April 15 or pay penalties and interest.
You should have at least a rough idea of your revenues and major expenses, so you can base your April 15 payment on those numbers. You can then use the extra six months to gather the necessary information and fine-tune the numbers on your return. If you overpay in April, you can get a refund when you file in October. But if you underpay in April, you may owe interest on the difference.
Use All Business Deductions
One of the biggest differences between filing as a self-employed person and filing as a regular employee is your overall tax liability: You're likely to owe more when you're self-employed than you would as an employee, because you must pay FICA (Social Security and Medicare) taxes as both employer and employee.
Fortunately, deducting business expenses can help you reduce your self-employment tax.
Try to take advantage of as many legal deductions as you can. In particular, look to make full use of deductions for business expenses and retirement plan contributions.
Deducts Operating Expenses
Make sure to deduct normal operating expenses such as:
Business travel in your personal vehicle (either by deducting the operating and maintenance expenses of the car based on the proportion that you used it for business travel or by taking the standard mileage deduction of 48.5 cents per mile for 2007).
Membership fees for trade associations.
Fees associated with accounting and tax preparation for your business.
Ordinary office supplies, such as paper, printer ink, envelopes and office postage.
A phone line used solely for business.
Money paid to any subcontractors.
If an expense was essential to the running of your business, deduct it -- provided you can prove it is essential if the IRS starts asking questions. For instance, claiming your new scanner as a business expense for your graphics company is fine, but claiming that a new 64-inch plasma TV was essential for your accounting business might be a tough sell in an audit.
If you work at home, the home office deduction can provide significant financial benefits. The deduction allows you to claim a percentage of your household expenses -- such as utilities, rent, mortgage interest payments, real estate taxes and home improvements -- as business expenses.
Contribute to Retirement Savings
With 2007 long gone, your ability to generate deductions for that tax year is limited. That said, you can still make a deductible contribution to a retirement savings plan until your final deadline for filing your taxes (if you file for an extension, you have until October 2008).
Contributions to qualified retirement accounts such as SEP IRAs are tax-deductible. If you pay a total of 30% in state and federal taxes, a $5,000 contribution to a SEP IRA or other qualified account will reduce your tax bill by $1,500 -- on top of the value of putting the money aside for retirement. (Remember that contributions to Roth IRAs are not deductible.)
For tax year 2007, self-employed taxpayers may contribute the smaller of 25% of total earnings or $45,000 to a SEP IRA. (Check out IRS Publication 560 for details.)
If you haven't set up a retirement plan, you have until April 15 to do so (or October if you've filed for an extension). Most plans are simple to set up. You can ask a financial adviser for assistance, or do it yourself at nearly any major financial institution's Web site.