Jobless Entrepreneurs Face Tax Minefields

Bryan Martin had always wondered what it would be like to run his own business, but it wasn't until insurance giant Zurich opted to shut down its regional Indianapolis office where he sold insurance that he decided to turn his pipe dream into a reality.

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"It's the scariest thing I've ever done," says Martin, who turned 51 last week and has a wife and 13-year old twin children. "Right now, I'm just worried about financially making this all work." (See 10 ways your job will change.)

Martin isn't alone. With the unemployment rate hitting its highest level in more than a quarter-century, a growing number of the nation's jobless are striking out on their own to pay their rent and put food on the table — some doing freelance and contracting work, others launching full-blown independent businesses.

But as the number of spanking-new entrepreneurs surges, so is the likelihood of tax errors and even — yikes — IRS audits.

"Absolutely, without a doubt, there's going to be more errors," says Jacob Gold, a CFP and author of Financial Intelligence: Getting Back to Basics After an Economic Meltdown. "The IRS will look at all of these new tax returns where people are declaring themselves as sole proprietors ... and I would not be surprised if the number of audits increased." (See the top 10 financial-crisis buzzwords.)

Many newbies, strapped for start-up cash, will likely try to cut corners by forgoing the use of accountants and attorneys and picking up TurboTax or other software to handle their taxes on their own, says Gold.

And there are plenty of newly minted entrepreneurs on the way. "We've seen a 50% increase in people looking to [start a business]," says Mitch Free, an angel investor and chief executive of MFG.com, a company that matches up businesses with manufacturers who can produce a company's products. "Once they've been pushed out of the nest, they're going to try to fly."

"There's been a discernible increase" in the number of clients opting to go out on their own in the past year, concurs June Walbert, a certified financial planner with USAA Financial Planning Services.

Many budding business owners grow wide-eyed at the prospect of generous tax deductions including those for business expenses ranging from travel and entertainment to home-office and computer costs. But many have no clue what is permitted and what will bring the IRS knocking at their doors. "There are many misconceptions about the tax laws, where people say, 'My neighbor told me I could do this,'" says Jackie Perlman, a tax analyst at H&R Block's Tax Institute. And a wrong or uninformed decision can affect the ultimate success or failure of the new business.

One problem for newbies is the sheer magnitude of available tax breaks. "When you're a self-employed small business, pretty much everything is a deduction, whether it's entertainment, marketing dollars or stationary," says Joseph Leonard, founder of Coastal Financial Associates and author of The Retirement Vault.

But those money-saving tax deductions and perks can quickly turn into profit-bleeding blunders that can threaten the very survival of a business. The most common mistakes: poor record-keeping, questionable deductions, failing to make quarterly tax payments to Uncle Sam and putting expenses on the wrong lines on a tax return. (See 10 perfect jobs for the recession — and after.)

It's critical that owners maintain books, records, separate bank accounts and different credit cards for the business, says Brenda Schafer, a CPA and CFP at the Tax Institute at H&R Block.

"In court cases, when people lose, it wasn't because they were attempting to deduct something that was nondeductible, but because they just had no records," says Perlman.

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