Although the risk of an audit may be statistically low for the average individual taxpayer, are small businesses at a disproportionate risk?
As background, the IRS employs certain red flags in its audit software. Since the IRS automatically gets copies of 1099s and W-2s, any mismatch between that reporting and a tax return may result in an automatic audit trigger. A large number of deductions, disproportionate to an individual’s income, may also raise a red flag.
For sole proprietors or self-employed individuals who file a Schedule C to report profit or loss from their business operations, special care should be taken. The IRS may give extra scrutiny to this schedule, and any loss reported on this form should be substantiated by receipts or documentation.
For example, there may be an unfair perception that income is under reported in cash-intensive businesses, such as bars or hair salons. In the event of an audit, the lack of receipts or documentation could prove a nightmare.
A small business owner should also take care to document any rental losses claimed on a Schedule C. There are special tax deductions that apply if you participate in renting out your own property or if you are a real estate professional who works at least half the time, and over 750 hours each year, in real estate roles like developers, brokers, or landlords.
If the IRS has flagged your tax return for an audit, it is important to have a tax attorney represent you through the process. There are many administrative steps in an IRS investigation, and an attorney can provide strategic advice at every step of the way.
Related Article: “Amid IRS budget cuts, agency remains committed to auditing returns,” copyright 2017, Baker Law Firm