You should get a 1099-MISC form from a client that you provided services to – so long as the annual amount is at least $600. The IRS requires this as a way to track income.
In other words, if you do not report the amounts on your tax return, you will get a letter from the IRS. Chances are you will owe taxes and interest on the unreported income.
OK, but what if your client did not send you a 1099-MISC form? Well, in this case, it is certainly much tougher for the IRS to detect this. But you should still report the income anyway. After all, if you are audited, the agency may look at your bank records and notice deposits. And if you do not have good explanations for these, then you will probably be charged with the taxes and interest on these amounts. Oh, and the IRS may get suspicious and start snooping into other parts of your business.
Something else: Even though the 1099-MISC has a $600 threshold, this does not mean you do not have to report income below this amount. Basically, the IRS requires that you report all income, regardless of the amount. Again, as noted above, if you have unexplained deposits, this could mean losing to the IRS.
For most home businesses, the income from your 1099-MISC forms will be included on Schedule C, line 1. You will list the name of the client and the amount. It’s a simple process.
Now, of course, the good part comes after this – that is, you can deduct your business deductions. On Schedule C, there are standard categories, such as for advertising, insurance, office expense, travel and legal & professional services. But there is an “Other expenses” category for anything that does not fit, such as for you Internet bill.
You will then subtract your deductions from your gross income, which will result in either a net profit or loss. This will be transferred to your 1040 form, on line 12. And yes, if you have a loss, this can mean paying a lower tax if you have other income.
Yet there is something important to keep in mind. If your business has not posted a net profit in any of the three of the past five consecutive years, the IRS may classify the activity as a “hobby.” This means you will not be able to recognize any losses. In other words, you may have to pay a hefty amount of back taxes and interest for prior years!
To deal with this, you need to prove to the IRS that your purpose is to make a profit. Some of the ways to do this is by showing that you keep the books, have separate bank accounts, you advertise, you have some type of business plan and have obtained the required permits and licenses.
Finally, when you receive 1099-MISC income, the taxes are not withheld. Instead, you need to do this on your own by making quarterly estimated payments. If not, you could be on the hook for interest and penalties.
To see how to comply, you can check out a recent post I did for HomeBusinessMag.com.