With the tax filing extension moving to July 15th this year, due to COVID-19, we will discuss the Top 5 Tax Audit Red Flags to Watch Out For.
1. Not Reporting All of Your Income
As you’ll remember from our blog on 1099’s which involved filing 1099’s, because the IRS receives a copy of all your 1099 and W-2 forms, they know what you should be claiming as income. As a reminder, you should be receiving a 1099 form from any vendor you worked with who paid you over $600.
Also, because more and more people are working virtually (even prior to March), the IRS has started working with third-party companies like PayPal. This helps them to determine whether you are reporting all the income you are making and makes it harder than ever to get away with discrepancies.
It can be easy to overlook income that you may receive due to the many sources you may have coming in. This is where it can get hard to keep track of everything. Unintentional or not, it will cause you headaches in the long run if you do not ensure your income level matches what is being sent to the IRS.
2. Mixing Business and Personal Expenses
As we covered in our blog: Top 5 Reasons To Stop Using Your Personal Bank Account To Run Your Business, this is important stuff.
In addition, the IRS uses business codes based on industries that show them what the normal amounts of deductions should look like (i.e.: excessive phone bills, high meal ((entertainment)) expenses, travel costs). At the end of the day you must PROVE these costs. Typically, a tax return that shows 20% or more than the typical amount of deductions may warrant a second look from the IRS.
3. Unusually High Charitable Donations
Charitable donations are one of the most popular forms of tax deductions. As an S-Corp you are able to contribute money to a specific charity that may be near and dear to the company heart, and you’re able to increase your tax break.
However, if you have suddenly decided to give large sums of money to a charity, this type of income shift could appear suspicious to the IRS. Some businesses may do this to avoid paying taxes, which is considered an abuse of the tax code.
To avoid getting audited, consider making yearly reasonable donations, regardless of your earnings. Also, keep receipts, bank records and written communications with charitable organizations ready to hand over to avoid the IRS scrutiny.
4. Overly Rounded Numbers
While a certain amount of rounding is acceptable when preparing business taxes, continuous even figures can draw attention and result in a red flag for your business. Experts suggest rounding to the nearest dollar, rather than the nearest ten or hundred. Believe it or not, it happens!
It is also important to never make guesses or use averages when preparing your tax returns. This can lead to mathematical mistakes, which will stand out to an auditor immediately.
That being said, in today’s world of electronic receipts and computer programs that do all of the calculations, if exact figures are available, use them. This type of red flag is easy to prevent and we can outline an easy bookkeeping system to alleviate this issue if you’re in the Stevens Point, Wausau, Wisconsin Rapids or Marshfield area.
5. Home Office Deductions
If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The home office deduction is available for homeowners and renters and applies to all types of homes.
There are two basic requirements for your home to qualify as a deduction:
- Regular and exclusive use.
- Principal place of your business.
But please note: the IRS is VERY specific about what can and cannot be claimed, so please read their requirements carefully; listed here. This can easily be another red flag if not properly understood and documented.
In Summation
Tax preparations are hard enough without the added stress of an audit that are a thorough and lengthy process. While there is no way to 100% audit-proof your return, the above tips will help you to avoid the red flags that could lead you down the path to an audit from the IRS.
If you have any questions, please reach out to us here!