Is Your Small Business in Danger of an Audit?

In recent years, the total number of audits on small businesses has increased at the IRS despite a decrease in the overall number of audits. Sadly, this change in focus by the IRS is based almost solely on their search for more revenue. Because of the nature and number of small business deductions, the potential for error is greater. If you qualify for a deduction don’t be afraid to take it, but be prepared to prove you deserve it. Below, is a list of some of the more common deductions that can set off a red flag at the IRS;

7 of the top reasons for an IRS audit

Home office deduction

There are two options available to calculate the home office deduction. The simplest calculation is the Simplified Method, which is strictly a square footage calculation. There are two primary areas where filers make mistakes with this one. The first is calculating the amount of square footage actually being used for the office accurately. Second, the office space must be used “…exclusively and regularly for your course of business…” The problem arises over subjectivity; what do they mean by ‘exclusive’?…or ‘regularly’? Should I include that part of the home or not? These questions can be difficult, but not impossible to prove and justify.

The second option is the Regular Method which takes into account a percentage of actual expenses for the home office space. This method involves a good deal of calculating and all of the calculations are dependent on the accuracy of the square footage amount being used.

In past years this deduction could raise a red flag, however those days are over. Don’t be afraid to take this deduction if you qualify just be prepared to back up your calculations.

Mileage deduction

The main reason this deduction raises a red flag is improper use of what constitutes business use of a vehicle and insufficient documentation. In order to claim miles, you must be able to prove the miles driven, the business reason, and the date. Sadly, most people just don’t keep sufficient records of this information; keeping a journal in your car will help, but you have to use it. There are also many great mileage tracking apps for smartphones. Again, don’t be afraid to take this deduction but do track all of the data the IRS requires.

Excessive expenses; especially high meal and travel expenses

Expenses must be ‘ordinary and necessary’ for the course of business. Meal and travel expenses are two of the most abused deductions. The IRS does use industry standards when reviewing deductions. So do take the deductions appropriate for your business but keep in mind excessive deductions can be cause for an audit. If you do not have receipts to back up the expenses and proof of the relevant business nature, these expenses can be disallowed.

Missing Income

If you neglect to report 1099 income properly the IRS is likely to know. They compare all 1099 filings they receive to the respective tax returns. So make sure to report all 1099’s on your return. Also, it’s wise to make sure you received the right type of 1099 and that the information listed is correct.

Losses on your schedule C

If a business continues, year after year, to have a loss on their schedule C the IRS could deem the business as a hobby. The IRS recognizes a business as having a ‘reasonable expectation of earning a profit’. This is another one of those troublesome subjective phrases that give the IRS too much room to work and the business owner no room for error. It comes down to this; If you haven’t earned a profit in more than two of the last five years you could lose your business classification.

Mailed vs Electronic Return

According to the IRS, a paper return is forty times more likely to contain an error. Due to this, paper returns create an automatic red flag. Do yourself a favor and make sure to e-file every time!

Mistakes

Typos on social security numbers, tax ID numbers, and names, as well as math mistakes, can be a signal to the IRS that the return was not prepared carefully and thus could include other mistakes.

It is important to keep good records throughout the year to be able to substantiate any item on your tax return. Lack of good record keeping is a top reason for most of the above deductions being disallowed. When you have doubts, seek professional help with your taxes.

For more tips and best practices check out our Guidebook, Becoming a Sensible Business Owner.

~ Brandon & Christi are successful business owners who enjoy traveling and making a mess in the kitchen with their two daughters.

The article is for informational purposes only and should not be construed as business, accounting or legal advice. Details are subject to change without notice.