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10 Audit Danger Areas You Need to Watch Out For

If you’re like most Americans, you breathed a sigh of relief when the IRS announced that due to budget cuts, they won’t be able to perform as many audits this year. But, before you get too excited, you should know exactly what that means.

Last year, the IRS conducted 1.2 million audits, and small businesses had a 1 percent chance of being audited according to WalletHub. This year, they will only conduct 1 million audits, and if the percentages stay the same, 10,000 small business owners will have to sit through an audit.

Reduce your chances of being one of those unlucky business owners by watching out for these ten audit triggers.

1. Deducting too many expenses

As a business owner, you’re entitled to deduct the expenses necessary to run your business, but you can get into audit trouble if those expenses are excessive or out of proportion with your earnings.

The IRS uses tables to determine the typical amount of deductions for each income bracket, and if your deductions are excessive, they might trigger an audit. In addition, if you deduct an excessive amount for meals, entertainment, or travel, the IRS may schedule an audit and ask to see your receipts.

2. Filing Schedule C

If your business is structured as a sole proprietorship and you file your taxes with a Schedule C, your chances of an audit is four times higher. Many people fudge on their taxes by taking extra deductions or underreporting their income on these forms, so they get closer scrutiny.

3. Claiming 100 percent use of a vehicle

The IRS is on the lookout for filers who claim 100 percent business use of a vehicle, especially if they don’t have a personal vehicle. If you legitimately use your vehicle solely for your business, be sure to keep mileage logs, and a calendar that documents the purpose every time you drive it.

4. Taking a loss too many years in a row

The IRS distinguishes between businesses and hobbies. You are permitted to deduct expenses up to the amount of income you earn from a hobby, but you aren’t allowed to write off losses.

On the other hand, you can write off losses in a business, but if you do that too many times, the agent may suspect that your business is actually a hobby and schedule an audit. If you legitimately run a business that’s taking losses, keep records of your business expenses and how much time you dedicate to your business.

5. Making simple math errors

It’s important to make sure all of your numbers add up, because a simple math error can trigger an audit from the IRS. In addition, don’t round up your numbers because the agent might think you sloppily prepared your entire return, which may make them want to take a closer look.

6. Dealing mostly in cash

If your business deals mostly in cash the IRS is more likely to audit you. That’s because they know some owners won’t report all of their income.

7. Overestimating donations

Contributing to charitable organizations is a good thing, but unless you do it properly, you could receive an audit notice from the IRS.

The IRS uses tables that show the average amount of deductions for each income bracket, and if yours exceeds it, it could throw up a red flag. Remember, you need an appraisal if you donate valuable property, and you should file IRS Form 8283 (PDF) if you donate non-cash items worth more than $500.

8. Earning too much money

While most people are in business to earn as much money as they can, earning "too much" increases your chances of an audit.

According to Kiplinger's interpretation of the latest IRS figures, people who earned more than $200,000 last year had a one in 37 chance of being audited, and those who earned $1 million or more had a one in 13 chance. Compare that to those who earned less than $200,000—only one in 116 of those returns were audited. If you fall into a higher income bracket, it’s vital that you keep meticulous records and document all of your expenses.

9. Not reporting all your income

Whenever a W-2 or 1099 is generated on your behalf, the IRS receives a copy of it, and if you don’t account for it on your tax return, the IRS computer will flag it. When this happens, the computer prints a bill for additional taxes and possibly an audit. Be sure to account for all of your income if you want to avoid an audit.

10. Claiming a home office deduction

Many filers don’t take a home office deduction even when they’re entitled to it because it has a reputation for flagging audits. But if you take it correctly and can back it up with documentation, there’s no reason to miss this valuable deduction.

Your return may be flagged if you take the deduction when you report a loss on Schedule C or when you show an income from wages. In addition, in order to claim the deduction, the area must be used exclusively for your home office. If you also use the room as a guest bedroom or dining room, you won’t be permitted to take the deduction.

The thought of an audit causes fear in many small business owners, but the reality is that if you file your returns in good faith and try to avoid these audit triggers, the chances of having to sit through one are pretty slim.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.
Avalara Author
Suzanne Kearns
Avalara Author Suzanne Kearns