The mere act of placing the envelope that contains a tax return into a mailbox may be a cause of stress for most taxpayers. None of us want to do anything that will alert the IRS to take a closer look at our tax returns. IRS examinations, or “audits” as they are much better known to most taxpayers, review returns to determine if income, expenses, and credits are reported accurately. Taxpayers who are self-employed, operate a cash business, use a home for business, or simply make business deductions tend to be larger targets of IRS audits.
*Taxpayer is self-employed
Sole proprietors are typically entitled to many tax deductions, such as deductions for home office expenses, mileage, meals, travel, and entertainment. Taxpayers use Schedule C to determine the taxable income from a business.
One of the automated mechanisms that the IRS uses is Discriminant Information Function (DIF), which scans every tax return received by the IRS. DIF is programmed to identify deductions that are above normal for different occupations and professions. If the average auto mechanic deducts 20% of income for business expenses and a return shows 30% of income as a deduction, the IRS will likely scrutinize the return more closely.
The IRS uses occupational codes on tax returns to organize and compare data. Taxpayers who claim 20 percent more than the average for a job or profession are more likely to hear from the IRS.
*Taxpayer operates a Cash Business/files a Schedule C
Taxpayers operating a cash business where they receive cash rather than a 1099 are more likely to end up on the list of returns necessitating a closer look and audit. The IRS identifies businesses such as restaurants, bars, barbershops, hair salons, car washes, and taxis as belonging to this category.
Although it may be unfair, the IRS believes that these businesses are more conducive to tax fraud and tax evasion since there is typically no record of anyone handing $75 to a barber for a haircut or $20 for two shots of whiskey.
*Taxpayer uses home for a business
Many taxpayers who use their home for a business have the tendency to apply the rules for deductions incorrectly. The fundamental concept here is that any area in the home used for business must be used exclusively for business. A home office can’t have the kids’ video game console and a spouse’s exercise machine sharing space with it.
The home must be used “regularly and exclusively” for business. The most important point may be that any wage earner making home office deductions may attract the scrutiny of the IRS, thus requiring that any home office expenses are well-documented.
*Taxpayer deducts business expenses
The IRS focuses on the deduction of business expenses based on the history of abuse of this type of expense. Any expenses for which an employer reimburses a taxpayer is not deductible. Any business deduction must have sufficient underlying documentation that consists of some record that is more than a simple receipt.
It’s practically unheard of reporting that a motor vehicle is exclusively used for business. Any taxpayer claiming the 100% business use of a vehicle will almost definitely cause the IRS to take a second look. The higher the percentage of business use that a taxpayer claims, the more important it is to have detailed, supporting documentation.
An Atlanta tax attorney can help any self-employed taxpayer take the necessary precautions to help ensure that there are as few red flags as possible on Schedule C. Consult a tax resolution attorney to learn more and resolve any tax debt problems. Call the Gartzman Law Firm at (770) 939-7710 or use our online contact form available here. Contact us today.