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If you work for yourself, this can be the time of year when dreams turn into nightmares. You probably have the cold sweats because you haven’t been making your estimated tax payments to the IRS for the past year. Now the bill has come due. Suppose, for example, in 1998 business was much better than you had anticipated. That’s good news-for the IRS. “You may owe substantial amounts of taxes, plus interest and penalties, if you underpaid your estimated taxes for 1998,” says Larry D. Bailey, partner in the Washington, D.C., national tax services office of PricewaterhouseCoopers. “What’s more, your first installment payment for 1999 will be due on April 15, and the amount you owe will be based on your tax liability for 1998.”
In short order, you’ll have to find a pocketful of cash. That won’t be easy, especially if you plow all your earnings back into your business, which is typical for the self-employed. The IRS, though, can be a nasty debt collector. When you’re caught between a rock and a hard place like this, where can you turn? Instead of buying an extra lottery ticket, there are some practical suggestions you can follow to solve your dilemma with Uncle Sam.
Reconstruct your records
Go back over your 1998 paperwork with an eye toward squeezing out every possible deduction. More 1998 deductions will mean less tax you’ll owe on your 1998 return as well as lower estimated tax payments in 1999. Fortunately, if you’re self-employed, you have some leeway in claiming legitimate deductions. Most of your legitimate business expenses (except capital expenses) are tax deductible.
What if your record keeping has been less than immaculate, a fault to which many sole proprietors admit? In some cases you can estimate what you spent-with the law on your side.
When you prepare your income tax return you can use any numbers you choose. Your risk is that the IRS will question your numbers. That means, you must justify (not “it seemed right”) your entries if you’re audited.
Don’t cheat; gray areas should be resolved in your favor if you have a reasonable explanation for your claims. “The better your records, the better your chances of supporting deductions, so it pays to take some time to keep current records of your expenses,” says Eardley G. Willock, tax manager in the New York office of the accounting firm Grant Thornton.
Suppose, for example, that you don’t keep track of every cab fare you pay. You estimate that you take three round-trip cab rides on business per week, at an average cost of $5 per ride. That’s $30 per week, or $1,560 per year. If you’re questioned, you’ll need to produce some evidence that you actually took those cab rides. You might show notes you took at client meetings, for example, in addition to a log that includes at least some records of cab fares during the year.
Where does the law come in? With the long-established “Cohan” precedent. George M. Cohan (composer of “Give My Regards to Broadway”