7 Small Business Tax Audit Triggers Owners Overlook

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Claiming 100% business use of an automobile is red meat for IRS agents. They know it’s rare for someone to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. GrowthForce accounting services provided through an alliance with SK CPA, PLLC.

H&R Block prices are ultimately determined at the time of print or e-file. Gig workers are also small business owners – which means extra tax rules and potentially IRS scrutiny.

Getting Audited

When most people think of an audit, they imagine a court scene in which you and your entire financial life are put under a microscope. Or people picture someone from the IRS showing up at their doorstep and demanding thousands of dollars. Over the years the IRS has received more information from third parties — not only from W2s, 1099s, and brokerage statement information, but also from flow through entities.

• You might have forgotten to report some of your income.
• Valid receipt for 2016 tax preparation fees from a tax preparer other than H&R Block must be presented prior to completion of initial tax office interview.
• An even $500 is somewhat unlikely, and the IRS may ask for proof.
• If you’re tracking your mileage by hand, you’re probably missing out on deductible mileage.
• Are entitled to and legitimately have high medical expenses.
• For example, if your home office doubles as a guest room, you can’t take any home office deduction.

But if the numbers reported are too generous, such as claiming more than half of a studio apartment, an examination becomes more probable. Carefully measure the square footage of your home. If you are not using a whole room, use a room divider or tape on the floor to get an accurate measurement of your work area to calculate your business percentage. If your tax return gets selected for audit, being able to easily find your records will expedite the appeal process. Here’s what you need to know about the top nine IRS audit triggers and what you can do to prevent headaches if you get audited because of them.

You Claim Your Hobby Is a Business

A CPA is strategically positioned to help small business owners prepare for what’s ahead. Math errors, typing mistakes, and missing documents like 1099s are big triggers for business audits. Double-check your math on your filing and make sure you include all the documentation required. Many businesses have turned to software to automate the increasingly complex sales and use tax compliance process. By taking these steps, business owners, executives, and employees can focus on what they do best — running and growing their businesses.

Find out how long the IRS has to audit your return, when most audits normally start, and how to know if you’ve been selected for audit. Sure, a lot of people use their cars for some part of their business. But if you’re also using it to shuttle kids to lacrosse practice, it just doesn’t qualify.

• Disgruntled employees, shareholders, customers and even suppliers or vendors sometimes alert the state to potential sales and use tax compliance errors or noncompliance.
• There’s little that’s more ominous to your small business than an IRS audit.
• Our intimate knowledge of IRS procedures can expedite your audit with a more favorable outcome than self-representation.
• It might be expected that you would spend 15% or so of your income on travel each year if you’re an art dealer, because that’s about what other art dealers spend.

If your preparer magically turns a $300 balance into a $300 refund, okay, but if he’s doing it for you then he’s probably doing it for everyone. I have seen IRS revenue agents roll their eyes when they see complicated expense categories come out as a nice even number. In addition, some mistakes cause the return to get kicked out of the electronic processing system and rerouted somewhere else. If you are at an office or shared network, you can ask the network administrator to run a scan across the network looking for misconfigured or infected devices. The real IRS will never initiate an audit via telephone.

What to Expect if You Receive Notice of an IRS Audit

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While no one likes thinking about the possibility of a tax audit, some prior planning can help you avoid this risk and get back running your business. Deductions are incredibly useful for small businesses and, as a leader, you’ll often be motivated to maximize them. However, to avoid an audit, you’ll want to ensure that this portion of your return has been prepared with immaculate accuracy. Essential small business Tax Audit Triggers Business Owners Should Know In 2021 tax documents provide justification and proof of your income and deductions to the IRS. Marcum LLP is a national accounting and advisory services firm dedicated to helping entrepreneurial, middle-market companies and high net worth individuals achieve their goals. Since 1951, clients have chosen Marcum for our insightful guidance in helping them forge pathways to success, whatever challenges they’re facing.

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We specialize in unifying and optimizing processes to deliver a real-time and accurate view of your financial position. Can actually make the reporting pretty straight forward (many brokerages have gotten a lot better with the information contained in their statements. Revenue agents will use the internet to confirm business locations, but other than a few isolated instances I have not seen too many challenge your expenses much further. Keep proper mileage documentation then they usually estimate this category by using numbers that end in a few zeros.

Tempting as it may be, don’t try any questionable moves just to get your income out of five figures, though. Like the mileage deduction, the home office deduction is often abused. Therefore, the IRS looks carefully at returns that include home office deductions. Overall your odds of getting audited arelikely low—just a few percent out of 100—but certain actions or deductions will increase the likelihood of investigation. The IRS uses complex algorithms to comb through tax return data and flag individuals for an audit. Having a high ratio of independent contractors to full-time employees can trigger an audit because businesses can use contractors to avoid paying payroll taxes.

Audits can be triggered at random, but certain kinds of taxpayers — and certain behaviors — are more likely to raise red flags with the agency. Given the complexities of recent tax law and audit procedure changes, enlisting the help of an expert might be your best business decision this year.

Take the home office deduction

Since tax software does all of your calculations for you, it has the distinct benefit of protecting you from this particular red flag. The credit has been targeted by fraudsters and real estate speculators.

Good records prevent you from making mistakes in reporting gross receipts and tax-deductible expenses. Claiming deductions that seem too high for your income level is another way to potentially trigger an audit. For example, if your small business brings in $50,000, but you claim $10,000 in charitable donations as a deduction, the IRS may want to look at those donations more closely. Renting property can lead to an audit if you report a loss. The IRS considers real estate a passive activity, meaning you are usually limited in the amount of loss you can claim. In some cases, though, your rental activities may be active, if you can prove to the IRS that you are a real estate professional. You qualify as a professional if you spent more than 750 hours in a year working in real estate and spent half or more of your working time working on your properties.

If you’ve received a notice of an audit from the IRS, exercise your rights as an auditee and get tax help from Tax Relief USA today. Once the dust settles and you’re no longer feeling irate, contact a tax professional at Tax Relief USA for help. A 30-minute phone call can be the difference in your fight against the IRS. While the list of small business auditees is broad, the expectations and processes of an IRS audit, and what a tax relief expert can do to assist you in the event of one, are very specific. Serving legal professionals in law firms, General Counsel offices and corporate legal departments with data-driven decision-making tools. We streamline legal and regulatory research, analysis, and workflows to drive value to organizations, ensuring more transparent, just and safe societies. Plumbers making hundreds of thousands of dollars or CEOs pulling in just over minimum wage will also likely be subject to audit.

• If you don’t report all of the income the IRS already knows that you have, this could show up as a clear discrepancy in the IRS’ automated system.
• If your preparer magically turns a $300 balance into a $300 refund, okay, but if he’s doing it for you then he’s probably doing it for everyone.
• It can request an extension to that statute of limitations, but you don’t have to agree.
• It sets priorities based on certain factors reported in the return and the person who filed it.
• The IRS already knows about income listed on your 1099 because the publication sent it a copy, so it’s only a matter of time before it discovers your omission.
• This is old hat to the IRS, so don’t think you can outsmart them.
• A recent Gartner report ranked industries based on how much they spend on the finance function proportional to their revenues.

If you have a hobby that is set up as a business, make sure to keep supporting documents for income and expenses. If you report losses on your Schedule C, Profit or Loss from Business, year after year, your return may raise some flags for the IRS. A business should be engaged in to earn money, according to the IRS. Usually, you must earn a profit from your business for three out of five years.

You Overlooked Income

The research and development (R&D) credit is one of the most popular business tax breaks, but it’s also one that IRS agents have found is prime for abuse. The IRS is on the lookout for taxpayers that fraudulently claim R&D credits and promoters that aggressively market R&D credit schemes.

So this tax audit trigger often originates with state tax agencies rather than the IRS. If you’re not yet at retirement age but you make a withdrawal or take a loan from your 401 or IRA, you may be subject to a tax penalty.

Engaging in Cash Transactions

Small business owners and limited partnership participants are at greater risk of being audited. Despite a year filled with pandemic-related tax changes, there are solid strategies businesses can put in place to eliminate mistakes and avoid an audit. The IRS knows that it is rare for someone to use a vehicle for business purposes 100% of the time, especially if they don’t own another vehicle for personal use. The IRS also targets heavy SUVs and large trucks used for business because these vehicles are eligible for more favorable depreciation and expensing provisions. The higher the business use percentage, the greater the IRS scrutiny will be.

The IRS using pretty much everything in its arsenal to trace activities of taxpayers who sell, receive, and trade or otherwise deal in bitcoin or other virtual currency. There is now a question on page one of the 1040 return asking about virtual currency activity. Fortunately, the nightmare is more fantasy than reality. https://quickbooks-payroll.org/ Only a tiny fraction of small businesses get audited. And when they do, they usually receive a letter—not a visit—from the IRS asking for more documentation to clear up a discrepancy. H&R Block provides tax advice only through Peace of Mind® Extended Service Plan, Audit Assistance and Audit Representation.

If the customer or individual who paid that individual the cash gets audited, the IRS will see a large cash disbursement from his or her bank account. The IRS agent will then follow that lead and ask the individual what that cash layout was for. Inevitably, the trail leads right back to the individual who failed to report that money as income. Still, that doesn’t mean you can drop your guard when it comes time to file your return. When returns are filed they’re scanned into the IRS computer system, which is designed to detect anomalies. The home office deduction is another expense that can blur the line between business and personal and lead to an audit. Home office deduction rules are very strict, so speak with a tax professional before claiming the deduction.

Using your car for business

With so many jobs eliminated in 2020, a lot of people took money out of their retirement accounts. Even if your LLC didn’t do any business last year, you may still have to file a federal tax return. If you expect to owe at least $500 in taxes for your business entity at the end of the year, you should be making quarterly estimated tax payments. Failing to make these payments can result in penalties and can put you at greater risk for an audit. Enrolled Agents do not provide legal representation; signed Power of Attorney required. H&R Block online tax preparation and Tax Pro Review prices are ultimately determined at the time of print or e-file. Terms and conditions apply; seeAccurate Calculations Guaranteefor details.