It’s a well-known truth that running a small business is considered an audit risk for taxpayers. Auditors have found that self-employed people often claim too many deductions and write-off expenses that aren’t strictly related to business purposes. Even if you’re keeping everything on the up and up, you’re lumped in with all the other sole proprietors and small business owners who are playing fast and loose with their deductions. Just because small business audits are common doesn’t mean they need to be a big problem.
If you own a business that flows through onto your individual tax return, here are some things that will lead the IRS to examine your return closely:
- Reporting at least $100,000 of gross receipts on Schedule C
- Running a cash-intensive business, which means your business receives a lot of small transactions in cash (such as a restaurant, small shop, etc.)
- Writing off lots of expenses for meals and travel
- Claiming 100% business use of a personal vehicle
- Deducting entertainment expenses, such as club memberships, sporting event tickets, or even meals purchased during entertainment events—entertainment expenses are no longer deductible under the Tax Cuts and Jobs Act
- Reporting significant losses on Schedule C that cause you to have little or no adjusted gross income, particularly if you receive income from sources other than your business
- Reporting losses from business ventures that may appear to be hobbies
- Claiming real estate activities that led to significant losses
- Selling, donating, or otherwise disposing of assets or securities that lead to significant losses (e.g. stocks, real property, vehicles, etc.)
Depending upon your tax situation, the only audit risk on this list that’s strictly forbidden is deducting business entertainment expenses. There are countless cases where the rest of the deductions and losses are perfectly legitimate; what’s important to realize is that you should expect extra scrutiny if any of the above apply to your business. If you aren’t sure, ask us.
In fact, if you know you’ll claim any of the individual audit risks we discussed a couple of weeks ago, be extra prepared for the IRS to manually review your return. When it comes to small business audits audits, your best defense is solid documentation and advance preparation. Use a professional bookkeeper to help you keep clean records with properly categorized expenses. Organize your documentation so you’re ready if you must show proof of what you plan to report on your tax return. Consult with a professional for any questionable deductions or tax situations so you understand exactly what you can deduct. Now is the best time of the year for tax planning as you have ample time to make proactive changes and understand your liabilities.