If you are a sole proprietor of your small business, you’ll need to report the income and expenses on the Schedule C Form. Many of the small business owners run their operations on cash transactions. Small businesses like cafes, taxis, bars, and saloons, etc. often run on cash-only terms.
All businesses that fall under self-employed or can be categorized as a “business” need to report their cash income. The most frequently observed mistake with cash businesses is failing to report the full income. It’s easier to forget a cash receipt than forgetting a recorded e-transaction.
IRS uses their comprehensive inventory of records to match the average income you report from a small business. Self-employed and sole owners can land in trouble if they report too low or too high of an income on their returns.
There are three closely linked types of small businesses that we can categorize as cash-intensive.
Owning a Cash Businesses
If you own a small cash-intensive business and fail to report the cash income properly, you are raising a red flag. Cafes, car washes, taxis, salons, bars, etc. all fall in such cash-intensive business categories.
Most small businesses report less cash income while deducting too many expenses. Tax deductions and business expenses must be backed by records. Most small businesses do record their expenses, the mistake they make is not having records on cash receipts.
Contrarily if you report too many cash receipts, that will also land you in trouble. Remember, IRS matches your returns against the industry averages for businesses of your size. Anything above $100,000 in a cash-intensive business may lead to an IRS notice for you.
Running a Home Business
Many self-employed and small business owners report a home-based business. Most of them report the office use of the home space. That enables taxpayers to deduct home expenses in proportion to the business activities.
So, what’s the IRS “red flag” here?
IRS would make sure that your office use of home space falls under the “regular and exclusive” use.
Exclusive Use of Home space for office means the portion of your house must be dedicated for office use only. This is the easiest way is to separate the home and office space.
Regular Use of Home space means that your dedicated space must be inconsistent use for business activities. You just cannot nominate the space and deduct proportional expenses.
A few tips to make sure that your home use of office space qualifies:
Segregate the office usage area and use it for only business purposes.
Separate your home and office stuff like printers, files, and racks.
Do not use the office dedicated space for personal use after business hours.
Deduct all expenses related to business use only.
All deductions with home and office use must be deducted in proportion only.
You Are Self-Employed
If you have turned your passion and hobby into a regular income stream, you’ll need to report it to the IRS. Freelancers and digital business owners need to report the income properly. You’ll need to report on form 1099-misc for freelancing or independent income. You’ll use schedule C to report net income or loss from the business activities.
Also if you contribute towards a retirement fund such as IRA, you’ll need to report it.
There is no minimum earnings threshold to report on a 1099-Misc form. As self-employed, you’ll need to report any income that you earn regularly as a job.
Some common mistakes to avoid as self-employed:
Not reporting IRA contributions
Disproportionate deductions from home-office space
Consecutive years showing as net losses
Disproportionate deductions of vehicle expenses
Excessive charity donations
Deducting personal meals, travel, and entertainments expenses without proportioning
Most independent contractors and freelancers have to file the estimated taxes quarterly. So keep your 1040-ES form in order for the estimated tax returns. Unlike a regular employee, all your taxes will have to be paid by yourself. The estimated tax form is a useful tool to avoid IRS tax penalties that can be around 6%-8% of your tax liability.
Non-documentation of income and expenses is the biggest reason for miscalculations in tax filings. Self-employed and cash businesses often lack the records when filing for tax returns. You need to report all income, even if you earn $5 from a freelancing gig. Only deduct expenses that you can back with records.
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