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Do you know the key indicators that make you more susceptible to an IRS audit?
As a small business owner, there are some red flags that could cause the IRS to audit you.
During an audit, the IRS reviews your business’s financial records. The IRS wants to know you reported correct information on your tax return. And if the IRS finds discrepancies in your records, you could face penalties or fines.
Do any of the points listed below apply to your business?
Avoid these 7 red flags that could get you audited by the IRS:
You can deduct purchases you make for your company on your tax return. To claim the deduction, your expenses have to meet some qualifications.
To be considered a business expense, the purchase must be:
You can’t claim purchases that were not made solely for your business.
For example, if you took your family to dinner, you couldn’t deduct the restaurant bill. Personal expenses never qualify as small business tax deductions.
If you work from home, you might be able to claim the home office deduction. You can deduct $5 per square foot of home office space.
Or, you can deduct your actual home business expenses, but you’ll need to have convincing records of everything you claim.
Your home office needs to meet these two guidelines to claim the deduction:
The IRS closely watches business that claim home office deductions. Make sure you file the correct amount and have financial records that support the deduction!
Like the home office deduction, you’ll need to follow specific rules when you deduct the business use of a vehicle.
Here are 4 examples of business vehicle deductions:
A red flag raises when you claim a vehicle for 100% business use.
For example, if you put 15,000 miles on your vehicle and claimed 15,000 business miles, you might get audited by the IRS.
Unless you leave your vehicle at your business, you probably drive it to commute to and from work. Commuting from home to work is not deductible.
Everyone makes mistakes, but an error on your tax return could be costly—and mistakes can lead to IRS audits, fines, and penalties.
A mistake on your tax return might mean you wrote down a 4 instead of a 9, or you might have forgotten a 0 or a decimal point. If you don’t use a recordkeeping system with automatic calculations, you could easily report incorrect figures.
The IRS pays attention to businesses who deal heavily in cash. Cash businesses are more likely to underreport income.
Cash transactions are more difficult to record:
The bank sends you statements for credit and debit transactions. You don’t get a statement for all your cash transactions. It’s easier to make recordkeeping mistakes without a bank statement to reconcile your accounts.
You can deduct charitable donations from your tax return.
The donations can be either cash or property to a qualifying charitable organization, and you can search for the federal database for a specific charity on the IRS website to see if it’s qualified.
Accounting for charitable contributions can be tough. To deduct charitable donations, you have to file certain IRS forms.
If you donate more than $500, for example, you must fill out Form 8283. For non-cash donations $5,000 or under, you must fill out Section A of Form 8283. For a non-cash donation more than $5,000, you fill out Section B of Form 8283. You also need to get a qualified appraisal for non-cash donations over $5,000.
If you do not get an appraisal or file the correct form, you could raise an IRS red flag.
There are some restrictions to the donations you can deduct: you can’t deduct charitable donations made to an individual person, for example.
You also can’t deduct your time or services. Say your company volunteered at a local food bank during business hours. You couldn’t deduct the money you might’ve earned if you were running your business.
Do you have workers at your business?
If so, make sure to classify each worker as an employee or independent contractor. To determine a worker’s status, you use the Department of Labor’s economic realities test.
The DOL test consists of 6 factors that help you decide a worker’s status:
Classify each worker as an employee or independent contractor based on the answers to the economic realities test. Be sure that you classify each worker with the correct worker status. Misclassifying a worker could raise a red flag for the IRS!
You need to correctly classify workers because an employee’s tax liability is different from an independent contractor’s tax liability. You don’t withhold payroll taxes from independent contractors, while independent contractors need to pay the employee and employer portions of payroll taxes.
If you have more independent contractors than employees, the IRS might take notice and audit you. It’s possible the IRS will suspect you’re misclassifying workers to avoid paying payroll taxes.