I subscribe to the notion that a good approach makes for a good landing. The same is true at tax time, when everything you’ve done in the previous 12 months can either make tax preparation as smooth as a soft-field landing or as unfavorable as bouncing one. If you have been keeping proper records the task of tax preparation is much less difficult. Like it or not, we need to meet our obligation to Uncle Sam. But that doesn’t mean it has to be a painful process. Here are five tips for making tax time easier on yourself—if not this time around, then use these tips to reduce the pain of doing taxes next year.
Record keeping is fundamental to tax preparation. The essence of your tax liabilities are in the records you keep.
- Use an accounting software program. I wasn’t going to add this seemingly obvious tip until I discovered that a busy, independent CFI friend was using a file folder as his “accounting system” because as he said, “I don’t want to spend the money on accounting software and I wouldn’t know how to use it if I had it anyway.” This otherwise intelligent CFI is stressing out about receipts, expenses, and making sure the income he states on his 1040 comes close to matching what will be reported to the IRS on the 1099s he receives. Our lives are stressful enough. Who needs more? If you are serious about being in business for yourself get serious about business record keeping.
Get help with keeping your books—we’re pilots, not accountants. Now for some self-disclosure. I hate accounting and bookkeeping! Sure, I had to learn basic accounting principles and software, but my primary job is flight instructing. If you feel the same as me then let someone else do bean counting!
- Hire a bookkeeper. If your business is thriving then you probably have a bookkeeper, spouse, or a trusted office manager doing this job already.
- If you can’t afford a full-time or part-time employee for the job, consider hiring a bookkeeper just for periodic (monthly or biweekly) on-site visits.
- The minimum you should do each month is ensure that you are recording your income and expenses along with balancing your books against your bank statements.
The bottom line—at tax time having your books in order by making sure your income, expenses, and assets and liabilities have been recorded and categorized correctly reduces your stress and can help your tax preparer decrease your tax liabilities.
Avoid issues with the IRS and the Hobby-Loss Rule. The IRS does not take kindly to people who start a “business” which is really their “hobby” and then attempt to claim expenses and losses on their tax returns. The IRS therefore supplies guidelines as to what qualifies as a business, also known as the Hobby-Loss Rule: Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit. The following factors are used as guidelines:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer depend on income from the activity?
- If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
- Has the taxpayer made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
To avoid having your losses disallowed, work hard to make a profit.
Independence comes with a cost. If you are self-employed (i.e. independent contractor), you are taxed differently than an employee. There are two separate federal taxes applied against your net income: the income tax and the self-employment tax.
- File estimated taxes on time (April 15, June 15, Sept. 15, and Jan. 15)
- Use the IRS form 1040-ES or file electronically using the Electronic Federal Tax Payment System (EFTPS).
- Have separate business and personal checking accounts. Don’t mingle personal checking accounts with your business.
- The price of being an independent businessperson is to act like one: Make sure you create invoices or sales receipts for all your customers and keep copies for these records.
- Be sure your employment status really does fit within the IRS definitions for independent contractor and that you are not a common-law employee or statutory employee. If it is determined you have been misclassified and you are an employee, you may have been denied overtime pay or benefits that were owed to you, or paid extra money in taxes.
Depreciate and deduct. Make the most of what you can legally depreciate or the expenses you can deduct.
- Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration, or obsolescence of the property. An airplane is a good example of property that can be depreciated over time.
- Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit. Car mileage, when the vehicle is used for business, is an example of a deductible business expense (with some exceptions). If you use your vehicle for both personal and business then keep a log sheet or use one of the many smartphone apps to help you maintain a record of your car’s personal and business mileage.
Taxes are not going away, so take two Aspirin, tackle what you can yourself, use an accounting system, and seek professional advice for the rest.
Small Businees/Self-employed VIRTUAL Small Business Tax Workshop Video Portal
Small Business and Self-Employed Tax Center
IRS website — Use it. Your taxes paid for it!