No one looks forward to being audited by the IRS, not the examination part, and not the potential penalties.
The good news is that if you’re smart—and yes, honest—you probably won’t be audited. Here’s a look at some of the most common audit “triggers”: the red flags that are likely to pique the taxman’s interest.
Overstating your deductions. Take legitimate writeoffs, by all means. But overdoing it could well raise the IRS’ antennae.
A common trigger is claiming luxuries as business expenses. If you claim deductions
for things like limousines, boats or extravagant travel, be prepared to back it up. And remember, very often your travel and entertainment expenses are only 50% deductible.
Crying poverty. If you claim your business hasn’t turned a profit for multiple years, or if you claim a large net loss for a certain year, it’s a red flag. Losing money for more than three out of five years suggests
your business may be more of a hobby, and thus not deduction-worthy.
Witholding payroll taxes. Suck it up and pay the taxes. The penalty for not doing so is the amount of payroll taxes you owe—and that can break your business.
Misclassifying your employees. Asserting that your employees are independent contractors—and thus that you don’t need to pay payroll taxes for them—is something that may happen quite by accident. But the IRS regards this as tax evasion, so guard against it.
Making a lot of money. If you file a Schedule C (the self-employment return form used by sole proprietors), and your income is over $100,000, you’re a big fish—or at least a somewhat big one—and your odds of being audited increase. Obviously, you should try to make as much money as possible. Just keep good records.
Claiming a home-office deduction. This is a common red flag. If you intend to write off your home office, be prepared to prove that the office is a well-defined room or area dedicated exclusively to business.
Overpaying relatives. If your office manager spouse pulls down more than office manager salary, it’s going to look fishy. Family members should be paid the same salary as if they were non-family members
with the same experience level, doing the same job.
If You Itemize You Deduction. Claiming a large charitable deduction on Schedule A could catch the eye of the IRS. If you have cash contributions, make sure you have receipts for these. A cancelled check is not good enough anymore. Also if you make donations of household goods or clothing, make sure they are valued correctly. Fair market value is what someone is will to pay for the item, not what you originally paid.
Claiming Employee Business Expenses. If you have to use your personal vehicle or travel a lot for business you may be able to write off reimbursed expenses on Form 2106. The key is to keep very good records. Mileage logs are a must. Keep all receipts for travel expenses If you are an over the road truck driver, make sure you keep a copy of your log books.
Filing a sloppy return. Filling out a return by hand, making all your numbers extremely round, leaving boxes blank. All of it smells fishy to IRS examiners.