Dad is wrong. Don't cheat.

Hey June!

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?

Tiffany
Fayetteville, GA


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.

Best,

June

PS: The people who pay you are not your employers. Only employees have employers. Employees receive W-2s not 1099s.

Exotic Dancer and more ...

I choose questions from indies that I think will be most helpful to the most people. I stay away from questions about unique situations that won't be informative to a lot of you. The situation below, from Michelle, although unique has a number of situations that apply to a lot of indies.

I've noted the distinct points or questions in red.


Hello June!

I have a very complicated question...or so I think! I am confused about pro vs hobby and what deductions I can take for this year.

My main job for the last 15 years has been as an exotic dancer. I am an independent contractor and have always filed a schedule C. I deduct traveling expenses (when working out of town) and supplies (costumes, shoes)

I am also a fine art photojournalist who is currently working on a photo documentary project to be published as a book. I plan on traveling often this year to shoot various photo projects and complete my book. I have also purchased plenty of supplies and equipment in this tax year as well and I have a home office dedicated as my studio. Since this is a ongoing project but I have received no income from it as of yet...can I still deduct travel expenses, equipment costs, home office, etc without profit?

Also, I have third business! I attended a yoga teacher training this year and will start teaching classes out of my studio (separate from the art studio) as of April 1st in my home. I have had to pay for paint, carpet, supplies to ready the studio for classes. I have been working on the studio since January and paying the extra rent myself. I do have a registered business name and business account. I will have very little profit by April 15. So am I entitled to deduct the home studio and start-up costs for the business this year? How about the teacher training and yoga classes as an education expense?

Since I have 3 separate businesses I am afraid of an audit due to all these deductions! What is proper protocol for multiple small businesses? Should I be worried about claiming too many deductions?

I would really like to do my taxes myself to avoid extra costs due to the fact I have paid a lot out of pocket to start up the yoga teaching and for photography equipment.

Your help will be greatly appreciated!

Thanks in advance!

Michelle
Portland, OR


Here's my response to Michelle:

The goal of a hobby is not to make money. The goal may be to have fun, help others, perfect a skill. A hobby may make money. You may deduct expenses only up to the amount of hobby income.

The goal of a business is to make money. As long as making a profit is your goal you don't have to actually make money. You may also enjoy yourself, help others, or master skills or develop a nascent talent. You may deduct all legitimate business expenses regardless the amount of income.

If the business is not yet "open for business" meaning you are not yet ready for clients or customers, then you are still in the start-up stage. Expenses may be deducted when the business opens. You may not deduct education costs to learn a new skill.

You say: I will have very little profit by April 15. April 15 is the first deadline for filing a tax return. It is, however, immaterial to income or profit. Calendar year taxpayers -- that's just about all of you -- group income and expenses from January 1 through December 31.

It would be unwise, time- and money-wasting to try to do your own tax return in order to save accounting fees. You have a complex three-indie-business tax situation; you lack knowledge of basic indie tax treatment; you have not had the time, or the rigor, to review my site and blog where you could have found all the answers to your questions. Would you teach yoga without first studying it? I wouldn't .

Put your time and energy into your businesses -- yoga classes, dancing, photos -- you'll earn more money, achieve success, and have the money to pay a tax pro.