{"id":580,"date":"2018-11-30T21:21:24","date_gmt":"2018-11-30T21:21:24","guid":{"rendered":"http:\/\/belbolcpa.com\/blog\/?p=580"},"modified":"2018-11-30T21:23:19","modified_gmt":"2018-11-30T21:23:19","slug":"8-red-flags-that-could-trigger-an-irs-small-business-audit","status":"publish","type":"post","link":"https:\/\/belbolcpa.com\/blog\/8-red-flags-that-could-trigger-an-irs-small-business-audit\/","title":{"rendered":"8 Red Flags That Could Trigger an IRS Small Business Audit"},"content":{"rendered":"

My colleague, Brad Paladini, has granted me permission to post this article that was originally posted on his blog:<\/a>\u00a0<\/em><\/p>\n

Last year, the\u00a0Internal Revenue Service (IRS)<\/a>\u00a0audited just over one million returns. That\u2019s a lot less than the 1.74 million returns they audited in 2010, but it\u2019s still no fun for the millions of taxpayers that had to go through the process!<\/p>\n

Overall, the IRS audits only about 1 in 200 returns. But some returns attract much more scrutiny than others. The IRS doesn\u2019t want to waste its time getting blood out of a stone, and so they focus their investigative efforts on those returns and taxpayers that are statistically more likely to have discrepancies, such as small business owners.<\/p>\n

Common Red Flags<\/h2>\n

Here are some of the major \u2018red flags\u2019 that can increase the likelihood of attracting IRS attention in the form of a small business audit:<\/p>\n

1)\u00a0 Higher Personal Income<\/h3>\n

While the\u00a0average<\/em>\u00a0taxpayer has a 1-in-200 chance of getting audited in any given year, those with incomes of over $1 million are looking at odds of 1-in-20. That is, if your income is greater than $1 million, the probability of your return being selected for audit is ten times greater than it is for the average taxpayer.<\/p>\n

At the same time, if you have an income of less than $200,000, the chances of your return being audited falls to just 1 in 154, based on 2016 numbers. But if your income was above $200,000, your chances of being audited increase to 1.70 percent, or 1 in every 59 returns.<\/p>\n

So, if you\u2019re showing an unusually high personal income, you are more likely to face an\u00a0IRS small business audit<\/a>. If you own a flow-through entity, such as an S-Corporation or LLC, the audit is likely going to extend to your New Jersey business as well, and any other business interests you own.<\/p>\n

The same is true of partnership income. If you are showing substantial income from a limited or general partnership, and the IRS flags you for an audit, the audit very well may extend to the partnership \u2013 especially if you are the managing general partner in a limited partnership and your K-1s are showing a lot of suspicious losses.<\/p>\n

2)\u00a0 Owning an All-Cash Business<\/h3>\n

Owners of businesses like restaurants, food trucks, convenience stores and other businesses that deal a lot in cash sometimes fall to the temptation to take cash transactions \u201coff the books\u201d in order to conceal income. Your credit card processor submits a 1099-K to the IRS detailing the credit card payments they\u2019ve made to your business account. The IRS has a pretty good feel for how much of a business\u2019s receipts are going to be in cash vs. credit cards, checks and other forms of payment. If your numbers are way out of whack for similar businesses in your industry, you can expect some additional IRS scrutiny.<\/p>\n

3)\u00a0 Suspiciously Low Salary Income for Corporation Owners<\/h3>\n

This is a common red flag for New Jersey business owners. Some business owners try to report as much income as possible as dividend income and little or no salary income in order to sidestep FICA taxes. The IRS is wise to this trick, and will often look closely at business owners who report W-2 salary as suspiciously low, compared to the size and profitability of their businesses.<\/p>\n

Some people fill out their Schedule C (Business Profit and Loss) forms to show\u00a0just enough<\/em>\u00a0income to qualify for an earned income tax credit or other lucrative tax credit, but not much more. This also attracts IRS scrutiny.<\/p>\n

4)\u00a0 Large Cash Transactions<\/h3>\n

Merchants must report cash transactions in excess of $10,000 to the IRS. Banks also report these transactions. Failure to report these transactions, or repeated transactions just below the threshold, could trigger IRS interest.<\/p>\n

5)\u00a0 Reporting Net Losses in Multiple Years<\/h3>\n

Reporting net losses in more than two years out of any given five-year period may attract a small business audit \u2013 especially for sole proprietorships, and any time business owners are trying to flow-through those losses to their personal income tax returns.<\/p>\n

To qualify as a bona fide business, as opposed to a hobby, your enterprise needs to show a profit in at least three out of five years. The IRS presumes that if you can show a profit at least three out of five years, you are running a bona fide business set up to make a profit. Otherwise, the IRS will look closely at your claimed deductions, and you could run afoul of hobby loss rules, and get some deductions disallowed. See IRC 183 for more information.<\/p>\n

6)\u00a0 Net Operating Loss Carrybacks or Carry-Forwards<\/h3>\n

Business losses can be carried back or carried forward to apply against income in other years. But the IRS is interested in these transactions. Be sure to document any such carrybacks or carry-forwards carefully to withstand an IRS small business audit.<\/p>\n

7)\u00a0 Excessive Deductions for Vehicle Use<\/h3>\n

The IRS looks closely at 100 percent business deductions for car expenses.<\/p>\n

First, you can deduct the IRS standard mileage rate for business use \u2013 54.5 cents per mile for tax year 2018 (as of this writing, the 2019 mileage deduction has not been released yet.) Alternatively, you can deduct your actual vehicle operating expenses, including fuel, maintenance, repairs, and upkeep. You cannot deduct both. If you try, you may attract IRS scrutiny.<\/p>\n

Secondly, be sure to carefully document the miles you drive and their purpose, and make sure the mileage you claim is genuinely deductible. For example, you can deduct expenses attributable to miles you drive to meet a client at a remote location, but you cannot deduct for mileage incurred driving from home to your office. That\u2019s a personal commuting expense, not a business expense.<\/p>\n

8)\u00a0 Suspiciously High Rental Property Expenses or Rental Loss Claims<\/h3>\n

Rental losses are unusual and attract IRS attention. The IRS may look carefully at any deductions you make for depreciation, and at attempts to deduct improvement and renovation expenses entirely in the first year, rather than spreading these deductions out over a period of years under MACRS rules.<\/p>\n

You can deduct repair expenses that are designed to restore the property to a functional condition in the year in which you incur them, but you cannot take a first-year deduction for improvements and renovations designed to enhance the value of the property. These you must deduct over a period of years, depending on the project.<\/p>\n

Labor expenses on capital improvement projects must also be amortized over the life of the repair. Failure to adhere to these rules can trigger IRS scrutiny.<\/p>\n

Facing an IRS Small Business Audit?<\/h2>\n

If you\u2019ve received a notification for a\u00a0pending small business audit from the IRS<\/a>, the tax attorneys at Paladini Law are ready to work for you. Attorney Brad Paladini has spent his entire career helping individuals and businesses solve complicated tax problems. Brad is highly trained to negotiate and fight with the IRS on your behalf. Schedule a consultation to have your case reviewed and explore your legal options. Contact Paladini Law through our\u00a0online form<\/a>, or call (201) 381-4472 today.<\/p>\n","protected":false},"excerpt":{"rendered":"

My colleague, Brad Paladini, has granted me permission to post this article that was originally posted on his blog:\u00a0 Last year, the\u00a0Internal Revenue Service (IRS)\u00a0audited just over one million returns. That\u2019s a lot less than the 1.74 million returns they audited in 2010, but it\u2019s still no fun for the millions of taxpayers that had […]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_genesis_hide_title":false,"_genesis_hide_breadcrumbs":false,"_genesis_hide_singular_image":false,"_genesis_hide_footer_widgets":false,"_genesis_custom_body_class":"","_genesis_custom_post_class":"","_genesis_layout":"","footnotes":""},"categories":[3,90,7,8,12,15,18],"tags":[151,39,55],"class_list":{"0":"post-580","1":"post","2":"type-post","3":"status-publish","4":"format-standard","6":"category-business","7":"category-debt","8":"category-expenses","9":"category-financial","10":"category-irs-resolution","11":"category-new-jersey-tax","12":"category-taxes","13":"tag-audit","14":"tag-irs","15":"tag-taxes","16":"entry"},"_links":{"self":[{"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/posts\/580","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/comments?post=580"}],"version-history":[{"count":3,"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/posts\/580\/revisions"}],"predecessor-version":[{"id":583,"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/posts\/580\/revisions\/583"}],"wp:attachment":[{"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/media?parent=580"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/categories?post=580"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/belbolcpa.com\/blog\/wp-json\/wp\/v2\/tags?post=580"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}