Have you ever wished for money to magically fall from the sky so that you could pay off your debts, buy a gorgeous new house, or travel around the world? You could casually drive around your neighborhood in a Lamborghini, and the figurative Joneses would be clamoring to keep up with you. Maybe you fantasize about winning the lottery and what it would feel like if you scratched off that magic ticket or ended up with the perfect combination of Powerball numbers, and how your life would change after receiving that multi-million dollar over-sized check.
If you are one of many Americans with “audit anxiety,” you’ll likely dread the idea of the Internal Revenue Service showing up at your house and rummaging through your receipts and bank statements to check for errors, penalizing you with hefty fines or even seizing your assets. Many myths surround the IRS, such as the belief that filing early increases your chances of being audited, or that there is a secret code in the mailing labels that target specific people.
The reality is that the IRS will audit less than 1% of Americans in any given year. Although some of the audits are at random, with nothing the individual taxpayer did to generate them, many inspections are instigated by mistakes taxpayers have made. The IRS uses something called the discriminate information function to determine which tax returns to audit. The DIF uses a scoring system that analyzes the returns of peer groups which are based on similar socioeconomic factors such as job category and income. If a person’s financial data differs significantly from those established by his peers, the system gives that return a high DIF score and raises the chances that the filer will be audited.
Here are some of the most typical IRS audit red flags and how to avoid them.
1. FAILING TO REPORT ALL YOUR INCOME
This is especially true for freelancers tempted to submit only the W-2 form from their regular job and keep extra income from side gigs on their Form 1099 (the non-wage income you get from things like freelancing, stock dividends, and interest) a secret.
However, the IRS already knows about the income listed on your 1099 because the company will have sent them a copy as part of their expenses, so it’s only a matter of time before your omission is discovered.
Service industry workers have historically been notorious for under-reporting their tips while achieving an enviably high net income, which is why the IRS is allowed to use a “reasonable estimate” of tips received by employees to calculate an establishment’s share of FICA taxes.
Currently, employees who work in industries where tips make up most of their income must now report their earnings to their employers. This includes cash tips as well as any tips paid by credit or debit card, along with the number of tips split with other employees. If the employer allocates tips rather than leaving it up to the employees to report, it means that they must pay taxes on tips equaling a share of 8% of your employer’s monthly sales.
2. REPORTING TOO MANY DEDUCTIONS OR CHARITABLE DONATIONS
Excessive or unwarranted deductions can raise red flags when they are too high in proportion to the amount of income, so business owners need to be careful not to declare too many expenses. For example, if you earned $55,000 as a web designer working remotely, home-office related deductions totaling $30,000 will raise a red flag. Context is important when validating business expenses, so trying to write off the value of a new dining room set as office equipment could draw unwanted attention.
The IRS also encourages individuals to donate clothing and even old automobiles to charities by offering a deduction in return for a donation. The IRS prefers individuals to value the items they donate somewhere between 1% and 30% of the original purchase price. Aside from the 30% and under rule, consider having an appraiser write a letter (for individual items valued at $5,000 or more, an appraisal is required. Another benchmark the IRS uses is the willing-buyer-willing-seller test, meaning that taxpayers should value their goods at a price where a willing seller would be able to sell his property to a willing buyer to purchase the item). This benchmark will keep you out of trouble and prevent you from placing excessive value on your mom’s old Nina Simone albums.
3. MATHEMATICAL AND GRAMMATICAL ERRORS
This may seem obvious, but if you have made a mathematical error, you will automatically get the computer’s attention. If you do your own return, it’s advisable to run it through a tax program. Also, make sure that the total dollar value of capital gains and/or losses are appropriately calculated.
Double check that your accountant has listed your income and expenses correctly to make sure there aren’t any glaring mistakes. They will also tell you if you’re deducting too many expenses in proportion to your income, and adjust the numbers accordingly.
When making your calculations, be precise and avoid illogical estimations. Consistently even numbers are a red flag that you’re attempting to have your numbers line up in intervals of $100. Round up to the nearest dollar rather than the nearest hundred. Say you’re a graphic designer claiming a program that cost $888.25 as a business expense, round up to $889, but not to $1,000. An even number such as $1,000 is somewhat unlikely, and the IRS may ask to see proof.
4. INCOME THRESHOLDS, BUSINESS OWNERS, AND TAX SHELTERS
Even though the cost of living continues to rise exponentially and you need a decent salary to survive if you earn more than $100,000 per year, your odds of being audited increase dramatically. In fact, some accountants put the odds of being audited at one in 72, compared to the one in 154 odds for those with lower incomes.
If you own shares in a limited partnership, control a trust or partake in any other tax shelter investments, you are more likely to be audited and need to document all deductions, donations, and income carefully.
Small business owners are an easy target for IRS audits–particularly those with cash businesses. Bars, restaurants, car washes, and hair salons automatically raise red flags, not only because they deal with so much cash, but also because there is a constant temptation to under-report income and tips. Also, many business owners put family members on the payroll and over-estimate expenses when paying with cash.
According to 2016 IRS estimates, there is roughly an annual $458 billion gap between what Americans pay in taxes versus what they owe, which equates to approximately $2,500 per household.
5. DISCREPANCIES BETWEEN SIMILARLY SITUATED TAXPAYERS OR CORPORATIONS
The IRS may compare the corporate tax returns of similar businesses and the relationship of purchases, sales and GST/HST remitted to other companies in the same industry to ascertain whether remittances are reasonable. They also look tax returns of shareholders of a private corporation to the corporation’s tax filings, so filing positions which are not consonant with expectations for an industry, or which are not consonant among shareholders and their private corporations, may attract an audit. The same goes for comparing the income and expenses of similarly situated taxpayers.
The IRS uses both automated and human processes when selecting which tax returns to audit. All tax returns are compared with statistical norms, and those with anomalies undergo three layers of review by personnel.
So what should you do if you are audited? Remain calm, communicate effectively, be prepared to show all of your documentation, and try to have a qualified accountant and/or tax attorney represent you.
Many people dread tax season. While a sizable return is cause for celebration, owing money to the IRS is never fun—especially when you haven’t budgeted for a high bill. Unfortunately, avoiding the debt won’t make it go away, and the IRS can be intimidating when it comes to getting paid. Here are some things to avoid so you don’t make your situation worse.
1. NOT FILING A TAX RETURN
If you have a feeling you will owe money you can’t pay, it can be tempting not to file your taxes. However, when you don’t file your return on time, the IRS automatically adds a 5% failure to file penalty for each month you continue to owe taxes, up to a maximum of 25%. You will also have to pay interest on your bill until it’s paid in full.
2. NOT FILING AN EXTENSION
An extension to file will gives you an additional six months to complete your return. Be sure to file your extension request before the April tax due date so you aren’t charged a failure-to-file penalty fee, although you will still owe on any outstanding taxes which equals 0.5% of the balance. The good news is that this penalty caps off at 25%.
3. HOPING THE IRS WILL FORGET ABOUT YOU
You can’t ignore the IRS and hope the problem will go away. In addition to penalty fees and interest, the IRS can cause you a lot of grief by canceling your passport, garnishing your wages, or placing a lien against your property. Know what’s at stake and take the IRS seriously.
The IRS offers payment installment plans to make things easier if you owe taxes and don’t have enough money saved to cover the amount. They also give eligible taxpayers up to 72 months to pay their debt in full, although interest and penalties will continue to add up in the meantime.
If you owe the IRS less than $50,000, you may be eligible for an online payment plan. If you owe more than this, you’ll need to fill out Form 9465 and send it to your local IRS office to find out what kind of plan you qualify for. If you end up being owed a refund in any subsequent tax years while on a payment plan, the IRS can apply it against your total debt.
5. NOT PAYING IN A WAY THAT’S BEST FOR YOUR FINANCES
When you’re struggling financially, it’s tempting to consider a loan to pay off your debt or use a credit card. However, this is something you have to research, taking the time to compare interest rates, fees and repayment terms for each option, so you’ll know precisely what borrowing to pay your taxes is going to cost you in the long run.
Paying taxes is never pleasant, especially when you didn’t expect to get hit hard with a bill. But facing up to it instead of avoiding the IRS is the best approach if you want to prevent more problems for yourself.
Love is a beautiful thing, and the most recent Royal Wedding has been a highlight in the news, more focused on the fantasy of Prince Harry and Meghan Markle than the day-to-day practicality of what happens once the proverbial knot is tied.
Unless you’re a royal who doesn’t ever have to handle such tedious things as finances directly, it can be a bit confusing when your status changes from “single” to “married.” Besides the daunting tasks of creating a household budget and saving for the future, a pressing question is whether you should file your income taxes jointly or if you and your spouse should each file an individual return. Here’s the plus and minus of each.
Married Filing Jointly
The majority of married couples file jointly in a single return that combines both incomes, exemptions, deductions, and tax credits—or even if one of you had no income or deductions. There are advantages to filing jointly, like qualifying for tax credits and possibly receiving higher income thresholds with the ability to obtain certain tax breaks depending on the amount of your dual income.
You can file jointly if, by December 31 of a tax year, you are either married and living together, living in a common law marriage recognized in the state where you reside, or even if you are living apart but are not legally separated under a decree of divorce. If your spouse suddenly dies and you don’t remarry within the year, you may file a joint return for the last year, but it will be the last one allowed with that spouse.
Married Filing Separately
If you’re married but intend on filing a separate return, then you will only report your own income, exemptions, tax credits, and deductions on your individual return.
If you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin), then the income you and your spouse earn is split evenly, as are your expenses (unless paid by one spouse with separate funds, such as inheritance money or pre-marriage savings).
There are many disadvantages to filing separately that might outweigh any benefits—such as not being able to deduct things like your student loan interest or the entire cost of child or elderly parental care expenses because dependent care assistance is limited to $2,500 instead of the $5,000 if you file jointly as a couple. Pivotal credits and deductions are reduced at income levels that are half of those for a joint return, including child tax credit, retirement savings contributions, and other deductions. Your capital loss deduction limit caps off at $1,500 instead of $3,000 if you file jointly.
If you own real estate and actively manage a rental property, it will be harder to deduct any losses you incur. If your spouse itemizes deductions, you probably cannot claim the standard deduction, but if you are allowed to claim the standard amount, this will be at half of what is allowed on a joint return.
Also, unless you are legally separated during the tax year, you’ll have to include up to 85% of any Social Security benefits as income, and you may not be able to deduct IRA contributions if an employee retirement plan covered either of you at work during the tax year.
Ultimately, most married people save on taxes by filing jointly, primarily when one spouse earns most or all of the income because it shifts the high earner’s income into a lower tax bracket. If spouses earn similar salaries, there shouldn’t be much difference in their tax rates whether they decide to file jointly or separately.
Just be aware that when a married couple files jointly, each spouse is liable for the entire tax amount that may be owed on the return, plus any interest, penalties, and fines if someone’s math ends up being terribly incorrect.
It’s always advisable to consult a professional accountant to make sure you are doing everything correctly and to the best possible financial advantage so that you too can live as happily ever after as the Duke and Duchess of Sussex.
Every year, droves of actors, models, and other creatives move to Los Angeles with the dream of making a name for themselves in a highly competitive film industry. For every successful Hollywood star, there are hundreds of others with grand aspirations who are struggling to make ends meet, working part-time jobs that allow them the time and energy to audition while honing their craft through acting, voice, or dance lessons.
These performers have long counted on being able to write-off everything from exercise classes to networking lunches without raising red flags with the IRS and suffering a tedious audit. However, deduction rules have gotten stricter as of 2018 due to the Tax Cuts and Jobs Act (TCJA), and it’s harder for professional actors classified as employees instead of independent contractors to deduct their job-related expenses from their taxes.
Actors with a regular gig used to be able to write-off their unreimbursed acting expenses as an itemized personal deduction on IRS Schedule A, these business-related expenses were only deductible if they exceeded 2% of the employee’s adjusted gross income. So if an actor with an adjusted gross income of $200,000 who had $40,000 in unreimbursed expenses could deduct $36,000 (2% of $200,000 = $4,000).
The TCJA eliminates the deduction for unreimbursed employee expenses for 2018 through 2025. This means that an employee-actor who spends $40,000 on business-related costs will not be able to deduct the expense and will ultimately end up paying more income tax. The Actor’s Equity predicts that some working actors could see their taxes almost quadruple. Although actors may seek pay increases to pay the extra tax or have some of their expenses reimbursed by their employers, for many this is not an option, and they are struggling to figure out how they can still legitimately deduct certain expenses to help alleviate tax burdens.
Before this enactment of the TCJA, any necessary expenses directly related to acting activity were deductible. If you were an employee-actor, you deducted the costs as an unreimbursed employee expense. Independent contractors deducted the charges as a business expense.
Typical deductible expenses for actors are as follows; some are still permissible while others are not:
Flights, hotels or other lodging fees, and 50% of the cost of meals during the trip. Local travel includes cabs to performances (both as player and observer), rehearsals, acting classes, auditions, and to pick up supplies.
AGENT & MANAGER FEES
Legitimate agents and managers should ONLY get paid when you do—and then they take a commission—10% for agents, and 10% to 15% for managers.
BUSINESS & PROMOTIONAL EXPENSES
Entertainers can write off a separate office or a section of a home office designated for the business. Business expenses can include video or digital cameras, audio equipment, theater and film books, musical scores, computers, and cell phones. Union dues, acting classes, and promotional items such as headshots, sizzle reels, advertisements in trade publications, business cards, cell phones, tickets to movies and plays, and subscription services for research such as HBO, Showtime, Hulu, and Netflix. Also, fees paid to accountants or attorneys fall under business expenses.
MAKE-UP & WARDROBE
Make-up, hair care, and wardrobe expenses are only deductible when they are connected to a specific job. For example, the cost of any clothing not suitable for street wear such as a business suit is not deductible, but a mermaid costume is.
Expenses that raise IRS red-flags would be things like hair styling and nails unless you are a hair or hand model, make-up unless you’re a professional makeup artist, or gym memberships unless you happen to be a stunt double. Even if you can make a good argument for these expenses contributing to your appearance and helping secure bookings, an IRS auditor will probably not accept them. This is because any full-time business employee could theoretically argue their need for those same items to further their career, and since they aren’t allowed those deductions, neither is a performer.
If your deductions are over $13,000, you may want to consider starting a loan-out corporation (either a C-corporation, S-corporation, or LLC) so that you can still write-off those expenses.
Usually, a movie or TV show hires an individual actor for a job. In a loan-out arrangement, the individual has “incorporated himself” by setting up his own company which technically employs him and then “lends out” his services to the entertainment production. But this is only worth it if you begin earning a significant income of at least $75,000 as an actor because the loan-out has to pay Social Security and related taxes for both the employer and employee, meaning an additional 7% of income up to approximately $127,000. Also, the cost of corporate documents and filing taxes for loan-outs can be as much as $5,000-$10,000 per year because it requires the expertise of specialized lawyers and accountants.
Setting up and maintaining a loan-out is complicated, and if associated tasks are not done correctly and at the proper frequencies, could result in significant penalties by the labor commission, audit risks, and a lot of back-taxes owed on improperly-paid income.
Be forewarned that employers may also hesitate to hire you since loan-outs introduce additional complexity and costs for them. Of course, many studios and production companies are willing to agree to these terms to secure a star actor, writer, or director, but they may be less willing to do so for those who aren’t so prominent.
Furthermore, it doesn’t make sense to incorporate until you’re netting at least $119,000 a year, but if you’re doing other business as an independent contractor within the same industry (i.e., an actor who also directs, or an actress who is also a make-up artist) then you can have everything go through the corporation instead of getting a 1099.
Keeping detailed and accurate records of everything you spend is the best defense if the IRS decides to challenge any of your expenses as nondeductible. Entertainers do incur many costs to climb to the top of their industry, but the divide between personal and business write-offs can be blurred. Professional advice from an accountant is the best way toavoid raising IRS red flags—and that is an expense which you can legitimately write off!
In our digital age, it’s interesting to go back and look at the origins of what society needs prompting certain technological advances, like the way we are fascinated by museum artifacts and antiques that give us a glimpse of what life was like in another era.
The history of accounting can be traced back to ancient civilizations and is closely related to developments in writing, counting, money, and early auditing systems by the Egyptians, Mesopotamians, Greeks, and Babylonians. IN 1000 B.C., the Phoenicians created an alphabet with accounting so that they were not cheated through trades with ancient Egyptians. Accountancy migrated to Europe towards the end of the Crusades, which saw a rise in trade between Europe and the Middle East. During the Industrial Revolution, the auditing profession was created to verify what was going into and coming out of storehouses.
In the 1490’s, Luca Pacioli, the father of accounting, wrote a famous white paper called “Everything about Arithmetic, Geometry, and Proportion.” The treatise is based on research that he performed on the common practices of merchants in Venice, Milan, and Florence. He revealed that several merchants kept books of debts “he owes” as well as credits which means “he trusts.”
Before computers, bookkeepers relied on paper ledgers to record debits and credits, revenue and expenses. Gone are the days of hand-written financial records and mailing in tax returns which we painstakingly wrote on with our most legible penmanship. Machines such as calculators began to play a technological role in the 1800s, by the end of the century the punch-card machine was invented to speed up data, and the invention of computers completely transformed accounting in the 20th century.
When the IRS first began using computers in 1961, people were horrified. A controversy surrounding the IRS computers was reflected in the mass media. “Right on the Button” is an entertaining short film that the IRS made in the 1960’s to highlight the benefits of a computerized system and alleviate people’s fears of “Big Brother” taking over. To quell fears that computers would replace human jobs, the film emphasizes the IRS employees who are vital in maintaining and checking the system.
Video Credit: US National Archives
The shift towards computerized tax processing was revolutionary in speeding up processing times, discovering the errors that taxpayers made, catching tax evaders and scammers, and verifying that all U.S. citizens were paying a fair amount each year.
The Accounting Journal describes early accounting software as “handcrafted byte by byte over the course of months.” As computers became powerful, programmers created more platforms that could serve many different customers.
In the mid 80’s personal computers came out and soon there were several companies selling accounting software. The early versions were expensive and customizable, but as the market became more competitive, prices dropped drastically, and software was standardized to accommodate customer service needs. Peach Tree and Quick Books quickly dominated because they were the more reliable than small, independent software developers.
In the early 1990’s, a game-changing operating system called Linux was released to the public. It was an unprecedented jolt to the software industry, revolutionizing open source software and pioneering the path to web-based software.
Today, accounting software has advanced to such a degree that it’s able to handle every detail of money tracking, whether that means day-to-day bookkeeping for small businesses and independent contractors, or those seeking a more efficient way to do their taxes.
Tax software packages come in cloud-based and/or desktop versions. Cloud versions are convenient because the software and your return are housed online, which means you can access them through all of your devices with the same login credentials.
Nowadays, we can’t even imagine having to go through tedious manual processes to manage our finances. The challenge is how to choose the right tax and accounting software when there are so many options. Here’s a roundup of the best the market has to offer.
TurboTax stands out for its design and a workflow that makes it easy to enter all your tax information. It’s user-friendly, interview-style Q&A is like having a chat with a tax preparer who asks useful questions and knows where to put the answers on your return.
Paid users can get free, real-time help from a tax specialist through video using the TurboTax mobile app, and there’s an extensive resource for answers and research. A new feature is TurboTax Live—a high-end package that can handle virtually every form the IRS may throw at you, plus you get a one-on-one review with an actual Enrolled Agent or CPA before you file, as well as unlimited live tax advice from an on-screen CPA or EA.
TurboTax is more expensive than some of the other options. It easily costs over $100 for software and state-return preparation, depending on the version. However, if you google “TurboTax discount code” you can usually save $10-$30 every year, and the military can save up to $49. TurboTax offers free guidance if you get audited, but if you want actual representation before the IRS, you’ll need to buy the Audit Defense add-on product for $44.99.
Reportedly, Turbo Tax has some issues with integrating their accounts with their own various apps, but overall, it’s one of the most popular choices.
H&R Block’s interface wins points for being user-friendly and offering exceptional support. Paid versions allow you to import the previous year’s return from TurboTax, Tax Act, or any other tax prep company. It includes useful tools like a W-2 and 1099 photo import, which saves time on keying in numbers.
Because the software is housed online, you can log in from other devices if you prefer to chip away at your return here and there rather than all at once. The mobile app was recently redesigned to accommodate you doing your return entirely through your phone if you wish.
The chances are that you’ll have some questions during the tax preparation process, and H&R Block offers several robust support options. Many accounting terms are hyperlinked to clarify how specific terminology applies to you, and the software is quick to send confused users to a searchable knowledge base. Like most software packages, a banner runs across the top of the page to keep track of where you are in the process. Deluxe and Premium package users also get free online chat with a tax professional.
H&R Block users always have the option to visit one of the thousands of brick-and-mortar offices staffed with experts who can help with your return if it becomes overwhelming, and while the cost of this isn’t included with the software, they will be able to make sense of your haphazard calculations at a reasonable rate.
H&R Block also offers Tax Pro Review, an add-on that costs anywhere from $49.99 and $89.99 depending on which software version you buy. The tax pros handling these returns are “certified at H&R Block’s highest levels and are our most tenured and experienced tax professionals,” according to the company.
For an extra $19.99, you can purchase an add-on called Worry-Free Audit Support. This gets you one-on-one contact with a tax professional to help guide you through an audit and includes IRS correspondence management, audit preparation, and in-person audit representation.
QuickBooks is a comprehensive accounting software package developed and marketed by Intuit. Its wide range of products is geared towards small and medium-sized businesses and offer physical software accounting programs as well as cloud-based versions that manage invoices and pay bills, perform payroll functions, and organize write-offs for tax returns.
The ability to integrate with other programs is a significant advantage of QuickBooks. After using the product to input business income and expenses, users can easily export that data to their favorite tax preparation program to make filing income taxes less tedious. Receipt Capture is a feature that allows you to take photos of your receipts and link them to expenses right from your phone.
When QuickBooks’ online version was first released, users complained of sporadic crashes, random blue screens, and other anomalies, making it less than the equivalent of QuickBooks’ desktop version. Fortunately, updates have solved all the issues involving slow running speeds, the overall stability has strengthened, and the user experience is much better.
Another plus is the 24-hour support that’s included with all the QuickBooks plans. The first three months of all QuickBooks programs are currently discounted on their website, so take advantage of this offer while you can.
For years, QuickBooks and Peachtree (now Sage 50) were the gold standards in small business accounting software. QuickBooks still holds 89 percent of the small business accounting software market in America, but Sage 50 is an increasingly popular product that’s giving QuickBooks a run for their money.
Sage 50 provides secure billing and invoicing, inventory and cash flow management, Enterprise-grade security, and analytics reporting. It also includes built-in data checks that flag common accounting mistakes and suspicious transactions.
You can pull your accounting data into your everyday productivity tools like Outlook and Excel. Unique features like Sage Contact and Sage Intelligence integrate directly with Microsoft Office 365. Both the Pro and Premium offerings are 40% off on Sage 50’s website for a limited time until July 21, 2018 (Promotion Code D-1929-0002), reduced from $447.78 to $267.99 and $692.58 to $414.99 per year, respectively. The difference between Pro and Premium are additional capabilities such as being able to plan and track inventory, manage jobs and expenses, and add more users.
TaxAct is significantly less expensive than most of the competition. They offer a free version for basic returns, and the Plus version costs less than half of TurboTax’s or H&R Block’s comparable offerings. It has all the necessary features you would want, such as the ability to import last year’s returns, a W-2 import that also works with mobile devices, and some planning tools and calculators. Because the software is housed online, you can log in from other devices if you prefer to work on your return incrementally.
If you need help, TaxAct will put you in touch with a CPA or Enrolled Agent over the phone or through live chat, a rare bonus feature for software at this low price point.
TaxAct’s audit assistance consists of an FAQ page on its website, but for $39 (included in the Premium package), customers can buy a service from a partner company that includes a comprehensive response and resolution strategy, IRS and state correspondence, help with denied credits, and tax debt and tax fraud assistance.
TaxSlayer is a steal compared to much of the competition, and its interface is as attractive as the more expensive versions on the market and has similar features such as the ability to upload images of W-2’s and 1099’s as well as an extensive online knowledge base.
TaxSlayer guarantees that unless you receive the maximum refund to which you are entitled, they will refund you the purchase price paid. Their in-depth error is checking guarantees 100% accuracy, or they will reimburse you any penalties and interest charges.
Tax help is free for Premium and Self-Employed users, along with free audit assistance (users of other versions can buy it for an additional $29.99). However, this will only help you prepare for an audit and not representation in front of the IRS, and freelancers or anyone filing a Schedule C doesn’t qualify. The support coverage applies for three years from the date you buy the software. There is no audit defense available.
Wave is a free cloud-based accounting software geared towards small business owners and entrepreneurs, and it’s one of the best online resources for its target audience of over 2.7 million users.
It offers unlimited Invoices in any currency, Income, and Expense Tracking with the capability of receipt scanning, Payroll, and unlimited guest collaborators which means you can even give your accountant access. Wave accepts credit cards and bank payments (ACH) and allows you to run multiple business ventures through one account. You can connect Wave with PayPal, Shoeboxed, and Etsy and export financial reports in CSV or PDF format. Customizable sales taxes and at-a-glance dashboards, including cash balances and invoice status, means easy account reconciliation.
If your income was less than $66,000 last year, you probably qualify to use the IRS’ Free File program, which gets you access to free tax-prep software. This lets you prepare and electronically file your return without a fee using software from a consortium of about a dozen tax-prep companies. Some are brand names; others are more under the radar. If you answer a few questions on the site, the IRS will match you with the right software.
CERTIFIED PROFESSIONAL ACCOUNTANTS
If you are an independent contractor, then a CPA might be your best bet. If you have multiple sources of income, your taxes will be a lot more complicated than if you have one W-2 to record, and an accountant can help you sort through how to report everything correctly. If your income is more than $200,000 a year, an accountant is imperative since top earners are more likely to be audited.
An accountant also knows what’s new in ever-shifting tax law and can help you take advantage of the latest benefits and offer advice on what you can and cannot write-off as business expenses. An accountant can help you understand the breakdown and how to avoid future problems if you owe the IRS taxes. Most accountants understand how intimidating it can be going up against the government, and a solid CPA will stand behind you and help resolve conflicts as fast as possible.
If you’re embarking on a new business, then an accountant can help you prepare by ensuring that all necessary tax forms are filed correctly. An accountant can also assist you in improving your credit rating using tactics that speed up the process that goes beyond simply paying your bills on time.
If you inherit a significant amount of cash or property, taxes can be costly if you don’t have anyone to help you navigate the specifics. An accountant will help advise you on the present situation and help you reduce your taxes for the future. A CPA can help you negotiate with creditors and make sure you aren’t being +harassed.
If you have kids and want to contribute money to a college savings account, or even a trust, an accountant can help set all of that up. If you’re planning to leave a substantial financial gift, an accountant will have all the information on how to go about it while gaining the greatest tax benefits.
Whether you own a home or have rental properties, an accountant can help you manage the specific tax situations as well as the major benefits. Similarly, if you are about to go through a major life change, a CPA can help lead you through the transition. Anytime you get married, get divorced, retire, or have children your tax situation changes, and an accountant will help you navigate the waters.
CPA’s often also serve as consultants, offering advice regarding protection of assets, salaries, employment benefits, systems for data processing, and more. Hiring an accountant can be an excellent way to save yourself time, money, and stress. Costs will vary according to the services you request.
Moving from paper to computer was a significant evolution in accounting. Now that technology has advanced beyond the green and white alternating lines on paper that made it easier to follow a row of numbers across a 36-inch ledger page; we are entering an era when we will interface through browsers and servers rather than loading software onto our computers.
Web-based accounting packages also aid scalability. An entrepreneur can never really know if his business idea is going to attract 10,000 users or one million, so he or she must be prepared to accommodate both.
Steven Cohen, the Managing Director of Softline, recently declared, “I believe that we are seeing the final revolution in accounting software. Mobility is a new paradigm for the business world. Say all your computers were stolen. In the cloud, you’re still up and running. Now accounting packages can grow endlessly and will never be obsolete. Development takes less time. There will never again be a need to create new software because of a platform change. Web-based software can be integrated with any process anywhere in the world. There will be no more running to the accountant for various reports – it is served on demand.”
As always, the right tax and accounting software will be whatever works best for you. With all the free trials available, it’s easier than ever to test out different options before committing to buy.
Approximately 53 million Americans—34 % of the workforce—are independent contractors (also known as freelancers). This population contributes $715 billion each year to the economy through their freelance work. Projections indicate that by 2020 the number will increase to 43% of the total U.S. workforce.
Historically, there are a lot of industries that support the entrepreneurial spirit by relying on independent contractors. For example, fashion brands and film productions continuously hire a range of up-and-coming and established actors, models, hair stylists, make-up artists, photographers, writers, editors, and extensive support staff to bring creative ideas to life.
Other industries, such as magazine publishing, limit the hiring of full-time employees due to “head count” restrictions, deciding to save on HR costs by bringing in qualified freelancers who are willing to forgo the perks of health benefits and PTO for the prestige that comes with working for iconic brands such as Condé Nast or Hearst. Many of these independent contractors will diversify by taking on as many side gigs as they can handle, driven by the worry of their job suddenly ending if a magazine title shutters or if a boss decides to shake things up and replace all the freelancers with a new team.
The gig economy continues to increase as advances in technology facilitate flexible and remote work, powered by platforms such as Fiverr and Upwork, which match freelance talent with employers.
In addition to “Summer Fridays”—where companies give paid time off on the Fridays that occur between Memorial Day and Labor Day—many are also allowing their employees to work remotely one or two days a week.
According to FreshBooks, a cloud-based accounting company that conducted an extensive 2-year study on workplace trends, the number of self-employed Americans is expected to triple to 42 million people by 2020.
FreshBooks predicts that of the next 27 million independent contractors, 42% will be millennial’s. The survey also finds that Americans who already work for themselves are very content to keep doing so, with 97% of independent workers (up 10% from 2016) reporting zero desire to return to traditional work.
Some independent contractors are consultants, agents, or brokers. Others might be creative professionals, technical wizards who are part of the start-up culture, models and actors, or even part-time Uber drivers. Whether you own a business or are a freelancer who provides services to other businesses, you are considered self-employed. This means you must handle your taxes differently than regular employees and are required to pay self-employment tax if you have net earnings of $400/year or more.
For income tax purposes, you will automatically be categorized as a sole proprietor, which is simply the default for small businesses. You don’t have to pay to register your legal name with your state or with the IRS, and you don’t need to necessarily form a corporation to file taxes. However, if you are using a name other than your legal name (i.e. Graphic Design by Jane instead of just Jane Smith) then you must officially set up a registered Sole Proprietorship or LLC.
As a 1099 contractor, you must regard everyone who hires you as a client rather than an employer. An independent contractor must treat his or her work like an entrepreneur would, which means considering the formation of a separate business entity.
TAX BREAKDOWNS FOR AN INDEPENDENT CONTRACTOR
Independent contractors should receive a 1099 or W2 from any company using their services. They are subject to paying their own taxes, including self-employment tax (SE tax), which is the Social Security and Medicare tax paid at a percentage of net earnings. If a company neglects to send you a 1099 or W2 (or sends it after the deadline has passed) you should still report the income because it’s likely being deducted as an expense on their end. You don’t want the IRS to come after you years later, asking for clarification and charging a financial penalty for your oversight.
The self-employment tax rate is 15.3% with 12.4% for Social Security and 2.9% for Medicare. However, you can claim a federal deduction for half the SE tax you pay, which helps to lower your taxes.
According to the IRS, additional Medicare Tax applies to self-employment income above a threshold amount of $250,000 for an individual who is married and filing a joint return, $125,000 for a married individual who decides to file a separate return from their spouse, and $200,000 for all other categories.
You have the option to make estimated tax payments during the year to pay your SE tax and anticipated income tax, or you can pay when you file your return along with your business deductions.
The amount subject to self-employment tax is 92.35% of your net earnings. You calculate net earnings by subtracting your business expenses from your gross income.
Depending on the type of independent contractor you are, you may be selling taxable goods that require sales tax to be collected and remitted quarterly to state or local taxing authorities. This is where you may want to consider hiring an accountant to make your life easier.
THE BENEFITS OF SETTING UP YOUR OWN COMPANY
Since independent contractors (1099’s) essentially run their own business, it may be advisable to form a company. A Sole Proprietorship or an LLC are the best options for a freelancer. Filing your taxes won’t be that much more complicated than a personal return, but having a company will prove to the IRS that you’re contracting work as a legitimate business.
The Sole Proprietorship is the most common choice, held by one individual who is responsible for all the operations, assets, and liabilities incurred. Business profits are processed through the owner’s personal tax return and taxed accordingly. If you are providing a product or service without any business partners and have not set up any other type of legal entity for the company, then you’re automatically considered a sole proprietorship.
However, you do need to secure the required local licenses for your type of company and register your trade name with the county clerk if you’re doing business under a name other than your legal name (i.e. Steve’s Landscaping instead of Steve Smith). Processing fees vary according to each state and are relatively low. A Sole Proprietorship structure is ideal for freelancers who mostly work for a single company, low liability businesses, and small online businesses or hobbies that are basically just a part-time job for the owner.
An LLC combines the features of a corporation and a Sole Proprietorship or Partnership in terms of tax efficiencies and business flexibility. Limited liability means you can’t be held financially responsible for more than your investment in the company, which means the owner(s) of an LLC aren’t personally liable for company debts and obligations. The business itself isn’t taxed; rather, the profits run through the LLC member’s personal tax returns at the standard personal tax rates.
LLCs are ideal for independent contractors that need liability protection yet do not need to raise a lot of money from investors, but want flexibility in how the business is being managed and taxed. Note that in addition to the cost of setting up the LLC and publishing a business announcement, there is a yearly fee that ranges from $800-$1,000 for the privilege of doing business in the state of your choice.
The most significant benefit of being an independent contractor is being able to write-off all your business expenses, which can add up so fast that you’ll only have to pay minimal taxes after deductions, or even be lucky enough to get a sizable return.
Deducting expenses means that you must save every single receipt and keep track of how each one is business-related in case you’re ever audited. An expensive dinner with your significant other would not count as a write-off unless you happen to work together, but theater tickets to a Broadway show if you’re an actor, director, writer, or producer within the entertainment industry would be considered a business expense.
The most common tax-deductible self-employment deductions include the cost of a home office (a complicated percentage-based calculation that an accountant can help you with), office furniture, your laptop/desktop, cell phone, internet, business travel, and transportation. Depending on what industry you are in, you may be able to write-off classes, magazine or streaming subscriptions, and even specific types of wardrobe items.
THE DRAWBACKS OF BEING THE BOSS
Everything is your responsibility when you are the boss, and this comes with a variety of advantages and disadvantages.
It’s up to you to make decisions when it comes to your rates, and it requires constantly marketing your services with a view to expanding your business, making sure that clients pay you on time, and balancing overhead expenses for everything from office space to business cards to travel to hiring other freelancers to help when you’re overloaded.
You also won’t get any paid time off for vacations or sick days. Employer-subsidized health, life, disability, and retirement benefits represent part of the “hidden paycheck” for employees that independent contractors obviously don’t get to enjoy. You are responsible for your own health insurance—which is expensive—and if you have a serious medical or dental emergency, you may have a hard time when it comes to paying the bill.
There is also the risk of not having enough income to live on when business is slow, especially when it comes to work that’s seasonal in nature. A lot of companies put off hiring freelancers during the summer when key staff members are on holiday, especially during the “dead” month of August. An independent contractor must be diligent in trying to set money aside to cover basic expenses when clients are scarce, although this can be challenging in the early days before you’re established in your career. You also have to plan for the future so that you won’t still be working when you’re 85 years old.
Setting up a company structure such as an LLC will help you avoid paying both personal and corporate taxes, but you will have to pay the self-employment tax on income generated through the LLC and make quarterly estimated payments to the IRS. Independent contractors must make sure they don’t pierce the “corporate veil,” meaning that they must operate the LLC as a legitimately operating entity with a distinct difference between the LLC and its owner.
Sometimes there is also an emotional toll that comes from feeling isolated as an independent contractor. If something goes wrong for an employee, it may not be so bad because it’s often part of a group failure. Short of termination, the personal financial consequences aren’t devastating because there’s still a salary. But a self-employed person suffers on all fronts. Often the failure is their responsibility, and financial consequences are immediate. If a client pulls out of the contract or if a bid isn’t accepted, there’s no cash flow coming in. Because of the precarious nature of freelancing, you must constantly sell yourself and seek out new clients through networking, just in case.
Ensuring that you spend your time wisely is your responsibility. Managing client expectations is important. You can’t just hope for the best and assume that a client will be impressed by the quality of your work—unfortunately, they often don’t even realize how much effort you’re putting in. You should always negotiate the details up-front so they won’t be shocked when you send them the bill. Guard your reputation because any attacks on your credibility from a dissatisfied client can hurt your business. Go above and beyond the call of duty and don’t allow any room for reproach. It’s important to constantly observe their sub textual cues, reassure any doubts, and be prepared to change direction when something isn’t working.
Sometimes, it’s easy to get caught up in the excitement when there’s an abundance of work. But trying to do everything all by yourself is a surefire path to burnout. Don’t fool yourself into thinking you can produce a huge amount of work on an unreasonable timeline just because that’s what the client wants. And as your business grows, you’ll have to let go of some of the control and learn to delegate responsibility to support staff you can trust.
Whether you decide to be an independent contractor who sets your own schedule or prefer the stability of being a salaried employee with benefits, it’s important to educate yourself on the best way to manage your finances as well as client relations so that you can achieve long-term success.
Instead of avoiding the IRS, communicate with them and arrange to pay in installments. Because of interest rates and late fee penalties, the longer you take to pay your tax debt means you’ll owe more money, but a well-qualified Tax Resolution Specialist can help negotiate the lowest possible monthly payment.
It’s also important to evaluate what circumstances led to you owing the IRS in the first place so that you can take steps to adjust your financial strategy. For example, filing as “exempt” on your W2 is not a good idea—it’s better to deduct more taxes from each paycheck and end up with a tax refund rather than incurring future debt.
2. AN OFFER IN COMPROMISE
You can also negotiate to pay off the IRS at a reduced dollar amount through an Offer in Compromise (OIC). This option gives you the opportunity to pay a lesser amount as a full and final payment. Taxpayers who can fully pay the liabilities through an installment agreement or other financial means generally won’t qualify for an OIC, but if you do, you can save thousands of dollars in taxes, penalties, and interest. This may be an excellent option if paying your full tax liability would be a substantial financial burden.
According to the IRS, taxpayers may choose to pay the offer amount as a “lump sum cash offer” paid in 5 or fewer installments within a maximum of 5 months after the offer is accepted. If a taxpayer submits this type of cash offer, they must include a nonrefundable payment equal to 20% of the offer amount. This payment is in addition to the application fee and is usually nonrefundable, even if the payment offer is rejected. Instead, it will be applied to the taxpayer’s tax liability.
The second type of offer is called a “periodic payment” which will be payable in 6 or more monthly installments but within 24 months after the offer is accepted. When submitting a periodic payment offer, the taxpayer must include the first proposed installment payment along with the Form 656. This payment is in addition to the standard application fee and is usually nonrefundable, just like the 20% payment is necessary for a lump sum cash offer. Even while the IRS is evaluating a periodic payment offer, the taxpayer is required to make installment payments under the terms of the offer. These amounts are applied to the tax liabilities, and the taxpayer has a right to specify how the periodic payments will be used.
3. CURRENTLY NOT COLLECTIBLE
There is a program where the IRS voluntarily agrees not to collect on the tax debt for approximately one year. If a taxpayer can’t pay his or her tax debts, the IRS can declare a taxpayer “currently not collectible,” after they receive evidence that a taxpayer cannot pay. This is useful because you can file a collection appeal to halt any IRS liens, levies, seizure or the denial of an installment agreement. It also gives you the chance to explain how you think the debt could be resolved without the extreme actions of an IRS levy or seizure.
4. RELEASE WAGE GARNISHMENTS AND BANK ACCOUNT LEVIES
In addition to garnishing wages, the IRS can issue a bank levy to collect money from your checking and savings accounts for taxes owed. When the IRS levies a bank account, the bank is required to remove whatever amount is available in your account that very day (up to the amount of the IRS levy) and send it to the IRS unless otherwise notified. A necessary aspect of resolving your IRS debt is to obtain a release of the levy and regain access to your funds.
Ultimately, the IRS doesn’t want you to lose your home or live without the necessities, so there is some room to bargain for a release or modification to the garnishment if you don’t have enough money to survive with the levy.
The IRS has ten years from the date of assessment to collect all taxes, penalties, and interest from you. An expert tax attorney, tax CPA or tax resolution specialist can help resolve your back taxes and IRS problems just by advising and strategizing with you to wait out the decade-long expiration date. This is useful because you can file a collection appeal to stop an IRS levy, lien, seizure, or the denial or termination of an installment agreement. The collection appeal gives you the opportunity to explain how you think the situation could be solved without the IRS levy or seizure.
If you have missed tax payments and find yourself falling further and further into tax debt past the point of reasonable negotiation, it may be time to enlist the help of a professional. Our tax experts offer IRS tax debt help which can reduce the amount owed or negotiate an IRS installment agreement to get your finances back on track.
Fraudulent schemes have been around since the beginning of commerce. The first documented scam goes back to 300 B.C. when a Greek merchant called Hegestratos took out an insurance policy which acted as a personal loan. The terms of this agreement were that when a merchant borrows money, they agree to pay it back with interest when the cargo is delivered. The boat and its cargo would act as collateral in case the loan was not paid back, at which point the lender could then acquire the boat and its cargo. Hegestratos planned to sink his empty boat, keep the loan money and sell the shipment to make a profit. Like many devious plans, it failed, and he drowned while trying to escape his crew and passengers when they caught him red-handed.
Many fraud cases involve complicated financial transactions conducted by ‘white collar criminals’ who position themselves as legitimate business professionals, or the ludicrous promise of West African riches from a Nigerian prince. Other scams prey on our societal fear of authority, disguised as official correspondence from the IRS or FBI.
Internet fraud is the fastest-growing area of fraud because it’s difficult to verify the identities of individuals and the legitimacy of faraway companies. It’s easier than ever for fraudsters to divert visitors to dummy sites and steal personal financial information while hiding their actual location.
Fraudsters contact their potential victims through many methods, which include email, postal mail, or phone calls. Here’s a round-up of the most common fraudulent financial schemes and advice on how to protect you and members of your family, so you don’t end up becoming the victim of a money scam.
THE NIGERIAN PRINCE SCAM
Remember how exciting it was when you signed up for your first email address? Suddenly, you didn’t have to pick up the phone to share valuable information or a hilarious meme with friends, family, and business associates. Back then, you probably looked forward to checking your inbox. But as you signed up with your new email to access iTunes, receive important bill payment reminder emails, subscribe to the occasional newsletter, or download software, you quickly realized that much of the spam in your inbox was a fallout of ending up on email lists that were shared with third parties.
Then came those suspicious (yet somehow intriguing) emails that happened to be commonly known as the “Nigerian Prince scam”—which is officially the internet’s oldest hustle. Most of these involved the mention of a Nigerian prince or another member of a royal family wanting to transfer large sums of money out of the country.
Other correspondences came from the presumed director of the Nigerian National Petroleum Corporation to individuals and corporations. The man claimed that he wanted to transfer $20 million that was budgeted but never spent on to the recipient’s bank account. In exchange for transferring the funds, the recipient would be gifted 30% of the total. To start the process, the scammer asked for bank account numbers and other personally identifiable information, and if applicable, a few sheets of a company’s letterhead.
This type of transactional scam first became popular during the 1980’s when perpetrators mailed letters to households where the wife was in charge, addressed to an absent or deceased husband. After enquiring about his health, it asked what to do with the profits from an investment that totaled around $25 million. The letter ended with a phone number, presuming that the bereft wife would take steps to try and secure the funds at the expense of giving out personal banking information.
Nowadays, most of us are aware that a West African nobleman demanding $1,000 to send you back millions of dollars is a scam. But the underlying logic of these “pay a little, get a lot” schemes known as 419 frauds (the number 419 refers to the article of the Nigerian Criminal Code Chapter 38: “Obtaining property by false pretenses; Cheating”) still manage to con a lot of people. Some scammers even have accomplices in the U.S. that move in to finish the deal after the initial contact has been made.
The FBI still reports annual losses of millions of dollars to these schemes.
According to Microsoft researcher Cormac Herley, “By sending an email that repels all but the most gullible, the scammer gets the most promising marks to self-select.” Groups of fraudsters in Nigeria continue to make millions from these classic cons, refining their techniques and expanding their targets—and they’ve even gained minor celebrity status for their crafty machinations.
Many myths surround the Internal Revenue Service, and if you are one of many Americans with “audit anxiety,” you probably dread the idea of the IRS randomly showing up at your door and rummaging through your financial records to check for errors, penalizing you with hefty fines or even seizing your assets.
Sophisticated scammers have found a way to capitalize on this natural suspicion of the IRS by preying upon American taxpayers by pretending to be Internal Revenue Service (IRS) collection, officers. The scammers operate by placing threatening official-sounding calls to unsuspecting individuals, threatening them with wage garnishment, frozen assets, or even imprisonment if thousands of dollars are not paid immediately. According to the IRS, over 1.5 million Americans have received threatening calls (often from India), and have lost a lot of money to these call scams.
The reality is that the IRS will audit less than 1% of Americans in any given year and they initiate most contacts with taxpayers through regular mail delivered by the U.S. Postal Service. There are exceptional circumstances in which the IRS will call or come to a home or business, such as to secure a delinquent tax return or late employment tax payment or visit a business during an audit or other criminal investigations. Even then, taxpayers will usually receive several notification letters from the IRS in the mail before anyone ever rings the doorbell.
An advance-fee scam is a common form of fraud and targets victims using various tactics depending on the scenario most likely to succeed. According to the Federal Bureau of Investigation (FBI), “An advance fee scheme occurs when the victim pays money to someone in anticipation of receiving something of greater value—such as a loan, contract, investment, or gift—and then receives little or nothing in return.” If a victim makes the payment, the fraudster either invents a series of further fees or disappears.
An example of an advance-fee scam is when someone is trying to sell an item using a platform such as Craigslist. Say you are selling bedroom furniture set for $800. The scammer would pretend to be an interested buyer and ask you to hold the furniture until they found a delivery service to have it picked up. They would make sure to get your mailing address and phone number and go so far as to send an advance check for an inflated amount, such as $2,000. While you were looking at the check, wondering why they would give you more money than the asking price, they would reach out again and say it was a mistake. At this point, they would be counting on you having not immediately deposited the check that will inevitably bounce because it’s a fake, and aggressively hound you to wire the difference back to them.
If you tell them you’re waiting for the check to clear first, they will go so far as to call you from several different phone numbers and even threaten you with showing up at your door because they have your address. However, once the check bounces, they have absolutely no leverage and will usually disappear if you threaten to report them to the police.
This con originated from the “Spanish Prisoner Scam” of the late 18th century when select businessmen were contacted by someone allegedly trying to smuggle a wealthy nobleman out of prison in Spain. In exchange for a small amount of advance money to bribe prison guards, the scammer promised to share the financial reward from his family as a thank-you for bringing him home.
An archived letter from 1830 is similar to the dramatic type of language that’s sent through email nowadays: “You will undoubtedly be astonished to be receiving a letter from a person unknown to you, who has a favor to ask…” and goes on to talk of a mysterious casket containing a lot of gold and diamonds belonging to a late marchioness who probably never existed in the first place.
HACKERS WHO CLAIM THEY HAVE ACCESS TO YOUR COMPUTER
The latest terrifying email scam has attackers claiming they have hacked into your computer and have access to all your personal information which they threaten to share publicly if you don’t pay for their silence (usually $1,500+ in bitcoin). The subject line includes a username and/or password that you probably have used at some point so that it appears legit. But the attacker probably got it from a publicly available database of old leaked passwords and email addresses.
This scam preys upon our primal fear of being spied upon, and we second-guess as to the security of important saved documents such as digital scans of passports, social security card, or bank account information.
As the scam develops, there’s a good chance it may include credentials from a new breach. To keep yourself safe, use strong passwords combining numbers, letters, and special characters. You can also try using a password manager and turn on two-factor authentication on your important financial accounts.
FBI SCAMS AND REPORTING CYBER ATTACKS
If you search the FBI’s website, you will see an extensive list of scams, some of which we’ve touched upon, and many you’ve never heard of. The FBI would never send mass e-mails to private citizens about cyber scams, so if something shows up in your inbox that seems to be from the FBI Director or another top official, it’s most likely a scam. As part of the battle against fraudulent activity, the Federal Bureau of Investigation provides regular updates to protect you, so use them as a resource when you’re unsure whether something is legit or not.
In conclusion, the best way to combat financial schemes is to protect yourself by being aware of the clever tactics scammers use. Never wire money to a stranger or divulge sensitive information such as your bank account information or your social security number.
If you get an email you aren’t expecting that asks you to open an attachment or click on a suspicious-looking link; you need to delete the email immediately. Even if it appears to be from your bank or credit card company, it’s more likely a scam known as pharming. The Better Business Bureau advises consumers to ignore and delete any emails that make these kinds of requests.
Remember to pay it forward and help keep others safe by forwarding fraudulent emails to the FBI’s Federal Trade Commission at email@example.com.
As one of the least understood documents ever created by the IRS, the 1099–C-Cancellation Form inevitably strikes a feeling of dread into the hearts of those who receive it. Why? Because this form is for those who were so deep in debt that even their creditors decided to give them a break and either reduce or cancel their debt. Just when they are starting to feel some financial relief, a 1099-C Cancellation form shows up in the mail.
Now, why would someone have to pay taxes on canceled debt when he or she is already in a precarious financial situation that forced them to seek debt resolution in the first place? It seems counter-intuitive. Unfortunately, in the eyes of the IRS, canceled debt never really disappears—it only mutates into a new source of taxable income called debt income.
The IRS’ rationale is that when you initially borrowed the money, you didn’t have to pay taxes on it because you were contractually bound by an agreement with the creditor to pay it back. If you had been able to repay your debt, it would have evened out on paper. As a result, the IRS would neither know nor care about it because owing and paying debt is not something that’s usually even noted on taxes beyond writing-off certain business expenses if someone happens to be an Independent Contractor.
However, creditors who cancel a debt of $600 or more are required by law to report the debt discharge to the IRS by filing a 1099. In the eyes of the IRS, whenever a creditor releases you of debt, you are in effect receiving a payment you did not return, which is their definition of income.
Here you go with the good news and the bad news about what the 1099-C Cancellation of Debt Form means for you…
If you receive a 1099-C Form, try not to panic until you’ve explored all your options. You could end up being exempt from paying taxes on the debt income, and if not, you probably can exclude a portion of it.
Ultimately, negotiating debt income with creditors and the IRS is a complicated matter, so hiring a qualified tax professional with experience in debt-income cases may save you a lot of money and stress in the long run.