Tax Pitfalls For An Internet Newbie

After emerging wounded and bleeding from a recent IRS Field Audit, I picked up some clues as to how budding Internet Entrepreneurs can survive the ordeal with some semblance of financial health.

1. Make your paper trails complete.

You may think that a simple receipt will suffice. Hah! Be prepared to show not only a receipt but a logical trail showing what you purchased, what it does, how it was absolutely necessary in your business, and where the purchase shows up on your bank statements or credit card itemizations. Then provide an explanation of why it didn’t generate the income you thought it would (the reason you bought it in the first place). In addition to the self-reproach and frustration you encountered when the system you bought didn’t perform as promised, you now have to endure the humiliation of a Revenue Agent shaking their head over your gullibility in ever believing the sales hype Why DID I buy that thing anyway?)

2. Perfect your memory.

If you put $100 cash in your bank account, document exactly where it came from and why, because 3 years from now you will be asked for details as to why this unimportant sum should not be considered unreported income. A few garage sales a year and you have business income my friend, and that means self-employment taxes. Apply this advice to every deposit made outside your regular paycheck or retirement income. If you can’t remember what on earth it was, come up with a reasonable explanation and stick with it, through the doubtful head shakings and accusatory stares. Saying “I don’t remember” opens up a whole new can of worms.

3. Annotate your check register receipts.

Bought some books to build your business, for classes, for help with income tax? Having the clerk write out what you bought as simply “books” is too generic for an eagle-eyed Revenue Agent. And a ClickBank or PayPal receipt is meaningless unless you can document what was bought and why it was a business necessity. When you stock up on paper and printer ink at the local office supply store, make sure you pick a register that’s been recently filled so you don’t end up with an unreadable tape (and ink fades over 3 years) that will not pass muster, no matter how detailed your explanation. And just why do you buy so much ink? IRS agents don’t have home businesses and have no concept of how fast an inkjet printer gobbles up its supplies when you print out an e-book or two or five.

4. Web finances.

We have all experienced the nightmare of the first year on the Internet – the truckloads of money we cough up to buy e-books, software, and gadgets, plus put up websites that are going to make us a fortune. Did you make a huge profit your first year? Like most of us, you probably spent a lot more than you earned! Think that you can deduct those expenses? Forget it. These are start-up costs and even if some of them pass the scrutiny they receive (What exactly is an Auto-Responder? SEO costs money?), they’ll have to be amortized over 5 years. Who knows if we’ll even be on the net 5 years from now? Who knows if the people and sites we bought from will still exist in 3 years when “more detailed documentation” is demanded?

5. Giving is a two way street.

Next time you slip a $5.00 bill to the homeless guy at the end of the off ramp, make new friends by holding up traffic for 15 minutes while you have him complete a dated receipt including what he is planning on doing with the money. Don’t just put $20 into the Church offering plate, write a check and make sure you get a copy of it after cancellation. Never use those untended drop-off Goodwill boxes -- a list of your donations is meaningless without a signed and dated receipt. And just how much do you think those used clothes and household furnishings are worth anyway? A lot less than they will eventually sell for, that’s for sure. Don’t just sponsor your grandkids in their walkathons or hand over cash for cookies – get an explanation of when you gave, how much, and what the money is being used for. Remember that it’s your word against theirs in a situation where your word is absolutely worthless.

6. Make Map Quest your friend.

If you do a lot of driving for business, charity, self-employment, or to a second job, be prepared to justify every mile through independent verification. Your odometer may differ from an internet estimate but you can’t be trusted so use an outside source, however inaccurate. To be in really good shape, take screen shots of online research (there go the printing costs again) to prove the figures you claim.

Let’s face it. The IRS flips a two-headed coin and we always choose tails. The bottom line is simple: if you show income and pay taxes on it, they will never, ever, question it. If you overpaid because some of that income was excludable, they’ll ignore it. But find yourself in the unhappy position of losing money over the year, as 90% of all would-be home entrepreneurs do, then your life becomes an open book before the eyes of an eager auditor with redlining foremost in mind, trained to ferret out every weakness in your armor.

We can all only hope to eventually make “guru” status and move to the Caribbean to hang on to our new Internet fortune!

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