Too many people file their business tax returns and hope for the best. You must know about entries on your tax return that can flag you for an audit. In this article, we share some of the common risks that people take when completing their business returns.
#1 Underreporting Taxable Income Throws a Red Flag
Many people don’t realize when you get a 1099 or W-2 around the end of January; the IRS also receives a copy. Your reported income is matched up with the documents obtained by the IRS and should equal or exceed the amount indicated on these documents. All income you receive, whether it’s as a contractor or as an employee, or through a casual work arrangement, is taxable and should be reported on your return.
#2 Making a Lot of Money May Trigger an Audit
It’s a fact of life, the more money you make, the higher the chance that IRS will want to review your return with you! As your income increases, so does your chances of being audited. For instance, the average audit rate is one-in-250 returns. Suppose you earn between $200k and $1 million, your chances of being called for an audit rise to one-in 100. Earn over $1 million, and you’re looking at increasing the odds of an audit to one-in-41.
#3 Be Prepared for an Audit if You Have a Large Number of Deductions
Your accountant is not trying to make your life more complicated… You must save receipts for deductions you intend to claim on your tax return. Why? If your deductions seem disproportionately large for the amount of income you generate, that’s a red flag to the IRS and may increase the odds that you get audited. The solution here is simple. Save receipts, and you’re in the clear, even if you do get subjected to scrutiny through an audit.
#4 Businesses are Likely to Get Flagged For an Audit
If you file a Schedule C for your business, as a sole proprietor, you can trigger an audit by claiming too much income or a substantial loss for your business. Either way, the odds that the IRS wants to see what you’re up to increase. The reason for this is simple; sole-proprietors are notorious, in the eyes of the IRS, for underreporting income and exaggerating expenses.
#5 Claiming Business Losses Year After Year
If you are claiming a loss in your business year after year, a couple of things are true. First, you might want to look at your business model. Next, be aware that the IRS might consider your endeavors to be a hobby, rather than a legitimate sole-proprietorship in business to earn a profit. The rule of thumb is, you should show a profit at least three out of every five years, or two out of every seven years. So, beware of writing off everything under the sun to avoid the taxman!
#6 Claiming Business Meals, Travel, and Entertainment Expenses
The first rule of thumb is to keep your expenses for business meals, travel, and entertainment within reason in comparison to the income your business is generating. The rules have changed dramatically for claiming these expenses since the tax reform law of 2017! You can’t claim any entertainment expenses, so don’t get those season tickets for your “clients” and plan to write them off!
Keep detailed records for all receipts you intend to claim on your return. Make a note of the business purpose, the people you meet with, where the meeting takes place, and the amount you are planning to deduct. If in doubt, check with your accountant to make sure you can claim an expense.
#7 Watch Out for an Audit When Claiming 100% Business Use on Your Vehicle
If you don’t have access to another vehicle for personal use, chances are you’re not using your business vehicle for 100% business. Be very careful what you claim for vehicle usage for your business, or you may receive an audit in return! Keep a mileage log with dates and mileage, along with the purpose of the trip.
Also, if you are using the mileage rate provided by the IRS, don’t attempt to write off auto insurance, maintenance, or other car-related expenses. One more tip for vehicles and business use: Watch out for writing off mileage or expenses for big SUVs or large trucks, and especially don’t buy them late in the year. Your strategy for taking huge depreciation claims is quite evident when this is the case.
Need Help With Your Tax Strategy?
Defining and implementing tax strategies for your business doesn’t just happen at tax filing season; it’s a year-long process! Don’t leave your audit odds to chance! Contact us a JStevens accounting, and we’ll help you make sure your write-offs are working for you instead of against you!