I am a profession ballet dancer and teacher. This is my first year as an indie.
My question for you has to do with audits. Since I get 1099s that my employer fills out, what should I do if they are wrong (i.e. too short)? I asked my dad and he said not to worry because if I get audited they can only go by the 1099 and whatever amount is written on there. But I worry because that almost sounds too good to be true. If I get audited, is there any way that they can prove I made more money than my 1099 states? Help!!! AM I being too paranoid?
Well, Tiffany, Dad is wrong.
Hiding income is fraud. You are breaking the law if you do not claim all your income.
Hiding income does not give a positive, professional image of your business. It raises questions, such as whether you are a legitimate business. Do you want to be looked upon with respect in your business community?
There are many ways for the IRS to verify income. In an audit of an indie, the IRS does not simply look at 1099s. Every bank statement is reviewed and must match income. If the money coming in on the statements doesn't match the income on your tax return you must be able to explain why. If your lifestyle is Porsche but your income is Hyundai, then the IRS digs deeper.
Let's say that Dana's Dance school hired you to teach and Dana's bookkeeper incorrectly completed your 1099 with $500 income instead of $5,000. In an audit Dana would use $5,000 as her teaching expense. And she can prove it via checks or fees from her students. If the enterprising IRS auditor decided to check your return and found only $500 claimed as income you'd be in trouble. Is Dad going to pay your penalties and interest for you?
I say in my book, Self-employed Tax Solutions : The IRS is not a morality agency, it is a monetary agency. It doesn't care what you do for a living as long as you pay taxes on the income you make doing it. If you make your living as a hit man or a lady of the night or a drug dealer, be sure to pay the IRS its fair share. Remember the Chicago mobster, AI Capone? He wasn't sent to prison for murder, bootlegging or racketeering; he was convicted of tax evasion for not reporting the money he earned in his self-employed endeavors.
When the IRS calls for an audit its only purpose is to collect more tax money with some interest and penalty to boot. Criminal activity is not suspected. But if you are caught in outright cheating -- particularly in deliberately failing to report a significant amount of income -- the IRS will not hesitate to prosecute you.
If you are ever audited, and the IRS refuses to accept some of your deductions, you will have to pay the additional tax on the lost deductions and interest on that additional tax amount. You also may have to pay a late payment penalty of up to 25% of the tax owed. You'll be out some money, but you've simply had a legitimate disagreement with the IRS about a deduction: you will not be hit with criminal charges or fraud penalties.
A fraud penalty can be as high as 75% of the tax owed. That is in addition to the tax owed plus interest.
I think you better have a talk with Dad. Or maybe buy him my book for his birthday.
PS: The people who pay you are not your employers. Only employees have employers. Employees receive W-2s not 1099s.