Being your own boss comes with a great deal of independence and freedom. You can work at your own pace, choose your own workspace and set your own rates. However, the privilege of being self-employed also comes with some significant responsibilities. As a business owner, you’ll also be responsible for filing your self-employment taxes, which may put you at risk of an IRS audit.
No one wants to undergo a tax return audit, especially when you have to fend for yourself as a freelancer. Because you’ll be reporting your income and deductions, you must know what the IRS considers red flags when filing your self-employed taxes. Here are four common factors that may trigger a tax audit:
1. Home office space deductions
It’s not uncommon for self-employed individuals or freelancers to use their home as their office space to cut costs. However, you must list your home office deduction carefully as not to raise suspicion at IRS. Be sure only to write off the portion of your residence used exclusively for your business. If your home office doubles as a guest bedroom or anything other than work, you can’t deduct it as an office space.
2. Hobby businesses
If your business experiences consecutive years of income loss, this may also raise a red flag with the IRS due to the Hobby Loss Rule. The rule states that if a business reports a net profit of at least three out of the last five years, it is a for-profit business. But if the company reports a net loss in more than two out of the five years they’re running, the IRS will assume they are a nonprofit hobby business. If you intend to make a profit, but you have hit difficult times, you may have to prove your business’s validity to the IRS.
3. Significant travel costs
While you can certainly write off any business-related mileage or travel, it’s essential that you keep meticulous records of your vehicle usage and how it relates to your business to protect yourself and business from an audit. If the IRS suspects that some of your reported mileage was for conducting errands unrelated to your business, an audit could be in your future. Be sure to keep any relevant documentation, such as gas receipts or oil changes, to support your deductions.
If you are self-employed, you must handle your tax returns with care to avoid making yourself vulnerable to an IRS audit. By avoiding these common red flags, you can protect the business you’ve built.