Common tax mistakes for the self-employed include failing to pay quarterly estimated taxes, mixing business and personal finances, neglecting to track deductible expenses, and miscalculating net income. Other frequent errors include ignoring home office deductions, missing filing deadlines, failing to set aside enough money for the final tax bill, and not using accounting software.
Here are a few mistakes small business owners should avoid:
The IRS uses a combination of automated and human processes to select which tax returns to audit. Not reporting all of your income is an easy-to-avoid red flag that can lead to an audit. Taking excessive business tax deductions and mixing business and personal expenses can lead to an audit.
Here are some of the most common tax deductions for self-employed workers.
Businesses that show losses are more likely to be audited, especially if the losses are recurring. The IRS might suspect that you must be making more money than you're reporting. Otherwise, why would you stay in business? Most likely to be audited are taxpayers reporting small business losses.
Here are 12 IRS audit triggers to be aware of:
The IRS does not check every tax return. It does not check the majority of them, but the IRS implements methods that track certain factors that would result in a further examination or audit by them.
Yes, interest paid on business loans is generally 100% tax-deductible as a business expense. This includes interest on business credit cards, lines of credit, mortgages for business property, and equipment loans.
According to the rule, an expense is incurred and deductible in the tax year if it meets the “all-events test” and the economic performance in question occurs within 8½ months after the close of the tax year. The all-events test is threefold: All events have occurred that establish liability.
IRS hobby income is taxable
The IRS requires you to report all your income; hobby income is no exception. You pay taxes on your income whether you profit from a hobby or a business.
Lost earnings due to accident or illness
If your business stops, it doesn't earn any money. Insurance companies call thisa break in earnings or interrupted productivity. These breaks are some of the greatest risks for the self-employed.
The biggest tax mistakes people make include filing late, math errors, incorrect personal info (like Social Security numbers), forgetting deductions/credits (like EITC), misreporting income, not signing forms, and making errors with bank details for direct deposit, all leading to delays, penalties, or missed savings, with using tax software or professionals helping avoid these common pitfalls.
It's good to be specific, but there's a danger in words such as “everything,” “nothing,” “never,” or “always.” “You always” and “you never” can be fighting words that can distract readers into looking for exceptions to the rule rather than examining the real issue.
An IRS notice may alert you to a mistake on your tax return or that it's being audited. You can verify the information that was processed by the IRS by viewing a transcript of the return to compare it to the return you may have signed or approved. You can access your tax records through your account.
Ten Red Flags that Could Trigger an IRS Audit
The IRS $600 rule refers to a change in reporting requirements for third-party payment apps (like Venmo, PayPal) for taxable income from goods and services, where platforms must send a Form 1099-K if you receive over $600 in a year, intended to capture gig economy/side hustle income, though delays and phased implementation have adjusted the timeline, with current rules for 2024 using a higher threshold ($5,000) before fully phasing to $600 for future years, but remember all taxable income, regardless of form, must always be reported.
The IRS 7-year rule primarily applies to keeping records for claiming a deduction for bad debts or losses from worthless securities, allowing a longer period to file for a credit or refund, but it's not a universal audit limit; it's often a recommended safe buffer for general record-keeping, with the standard IRS audit period usually being 3 years, extending to 6 years for substantial income omission (over 25%) or foreign income issues, and indefinitely for fraud.
Many business expenses are 100% deductible, including advertising, employee wages, rent, supplies, and certain business meals like company parties or meals for the public, while personal deductions like student loan interest or charitable donations (depending on the type) can also be fully deductible for individuals. The key is that the expense must be "ordinary and necessary" for your trade or business or meet specific IRS criteria, often differentiating from the 50% rule for client meals.
One of the most common pitfalls for the self-employed is not reserving enough funds to cover their tax liabilities. Unlike traditional employment, taxes aren't automatically withheld for you. Failing to save for taxes can lead to financial strain when payment becomes due.
You can claim business expenses for: