– 9 Common Tax Audit Triggers

9 Common Tax Audit Triggers

Most business owners would say if there is one thing they fear and try to avoid at all cost  it’s a tax audit. Many live in fear of the unknown, wondering if their actions or accounting can trigger a visit from the IRS.

Audits are a normal part of the operations of our government. They are designed to verify the accuracy of your reported income and expenses. Even if you are reporting your finances accurately, you may still be a candidate for an audit. This is primarily because there are specific triggers IRS uses to red-flag for possible inconsistencies, understatements of income or overstatements of expenses. Knowing some of the triggers will help answer the question” Am I at risk for a tax audit?”

Our experts have compiled some of the more common triggers. They are listed in no particular order of importance. 
 
1. Reporting income that is higher than the average in your industry or profession. Based on statistics, just 0.9 percent of people who make under $200,000 were audited last year, compared to 10.9 percent of those who made over $1 million. If your schedule C shows more than $1 million in sales, the odds of being audited increase substantially. With such increased odds of being audited, you must keep meticulous financial reports.

2. Large deductions which look out of proportion to your sales or income. Deducting expenses which substantially reduce your taxable income are a red flag, especially if they seem proportionally too high as compared to your income. The IRS uses tables to decide if your deductions are too high for your income bracket. But don’t go searching for these tables because they aren’t made public. We know at times those out-of-proportion deductions are legitimate. For instance if you just recently started your business or during times of slow growth. For this reason, you must keep track of all your deductions along with the supporting documents. 

3. Reporting rounded numbers. How likely is it that your investment returns were exactly $1500, or that your mortgage interest deduction was $12,000? Reporting too many round numbers are deemed fishy by the IRS and can trigger an audit. If you made $72,532.65 don’t report $72,500. This kind of reporting may be deemed inaccurate and sloppy. if you are found to be inappropriately rounding in one area,  the IRS may assume you’ve done that in another area of the returnThey’ll view the entire return questionable.

4. Home Office Deductions. Because home office deductions can be so easily abused, IRS simplified how to calculate this deduction. But to take it, you’ll need to satisfy specific requirements and tests, which are strictly enforced. One such requirement is that the home office is used regularly as your place of business. Another is that the space is devoted exclusively to the business. For example, deducting a spare bedroom as a home office is perfectly fine if you use it constantly as your place of work. However, if this same bedroom also serves as a spare room for visiting relatives, it fails the exclusivity test. There are many other requirements for proper home office deduction, so please contact our experts or your CPA for more information.
 
5. Claiming Business Losses Every Year. Business losses are part of the small business world. The first few years are tough and sometimes you’ll go through a rough period after enjoying profitable years. If you often claim losses, you’ll be on the IRS’s radar. They might assume you’re taking deductions you’re not entitled to or under-reporting your income.
 
6. Filing a Schedule C. Most small businesses report their income and expenses on a Schedule C. Although this tax form increases your odds of being audited, don’t let that fear prevent you from filing this form. There is one way to avoid filing this form and that’s being setup as a corporation. It’s a well known, that businesses formed as a sole proprietors, LLC’s or partnerships are more frequently audited than corporations. 
 
7. Excessive Entertainment or Charitable Deductions. Entertainment expenses are one of the most common business deductions. Unfortunately, most business owners don’t understand how much is excessive and what entertainment can be claimed as deductions. Taking your family out for dinner or donating to your local charitable organization as a payment for a piece of art is not an allowable deduction. Having expensive dinners while traveling or membership in a country club would be considered in excess or completely disqualified. If your tax return has higher than average entertainment or charitable deductions based on your industry and income, IRS will notice. Keep in mind that entertainment and charity deductions must have supporting documents. For entertainment expenses keep a log of when, where, with whom and why the expense was made. Charitable deductions of more than $250 must have documentation. On the bright expenses less than $75 don’t need an accompanying receipt.
 
8. Claiming Your Vehicle As 100% Business Use. Most people get confused how to properly deducting your auto expenses. IRS offers you two options. Your pick depends on the one which gives you the highest deduction. You can use the IRS standard mileage deduction or the actual expense but you can’t use both methods in one year. If you claim 100% deduction of your automobile remember to keep all supporting documentation. This includes precise records that include mileage logs, dates, and the purpose of every trip. Keep in mind that this deduction is one that is frequently scrutinized by the IRS. 
 
9. Drastic fluctuations in income from year to year. This one is hard because plenty of small businesses have had an unusually good or a bad year, here and there. If your reported income one year is dramatically higher or lower than in prior years, you may be red-flagged. Fluctuations in income can signal mistakes, unreported income or overstated expenses. We strongly recommend that you keep proper records and have a good bookkeeping system to substantiate your figures.
 
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