This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should always consult your own tax, legal and accounting advisors to help properly manage your business.
IRS audit. These two words can send a shiver down the spine of nearly every business owner and subcontractor.
The good news is that the IRS audits fewer taxpayers than you may think—far less than 1% of all individual returns. The bad news? Those filing a Schedule C for profit-and-loss reporting on their business (like many subcontractors and service providers for the property preservation, commercial or residential rental segments) are much more likely to have the IRS take a closer look at their finances.
But there are steps you can take to help lower your odds. It’s helpful to start by understanding the most common IRS audit red flags and how to avoid them.
IRS Audit Red Flag No. 1: Inaccurately reporting your taxable income
Because the IRS receives all the same tax reporting forms that you do, if what you report in your filing doesn’t align with what they see, you could receive an auto-generated bill and/or be contacted for further investigation and potentially an audit, so be sure to report all taxable income from all sources.
IRS Audit Red Flag No. 2: Taking too many deductions
Did you know that one way the IRS assesses whether you’ve taken too many deductions is by comparing you to other subcontractors and what they report using special occupational codes? This goes back to the Schedule C scrutiny. If your deductions seem out of line with other service providers who do what you do, it could be a red flag for auditors. That’s why keeping accurate records and receipts—especially on larger deductions—is essential.
IRS Audit Red Flag No. 3: Blending business and personal spending
The IRS has strict guidelines regarding mixing personal and business expenses, and it’s important to understand what’s allowed and what isn’t. For example, business meals may be deducted, but only if you have a record and can verify business was discussed during the meal. Interest on a personal auto loan may also be deductible if you use it for your business, but only partially if the vehicle is also driven for personal use. If you aren’t sure if you can claim something as a business expense, work to confirm it online via a site that offers tips like Intuit or by asking your tax preparer for their guidance .
IRS Audit Red Flag No. 4: Reporting 100% business use of your vehicle
Yes, this is another case of mixing business and personal expenses, but it’s one that could be more likely than others to raise an IRS audit red flag. If you claim your vehicle is used solely for work, you’ll need the documentation (mileage, fuel receipts, repair records, etc.) to be able to back it up and also show that you have another vehicle designated for personal use. You’ll also need to decide whether it’s more financially beneficial to deduct your mileage or actual expenses on your vehicle. Check out this comparison overview of both methods to dig into the details.
IRS Audit Red Flag No. 5: Not keeping detailed records of your income and expenses
This is a tip you’ve likely deduced already, but it’s definitely worth repeating. From keeping your business and personal bank accounts and credit cards separate to faithfully filing invoices and receipts and recording your mileage in meticulous detail, careful record-keeping is critical. And, of course, above and beyond your personal business records, as a property services subcontractor, you’ll be required to keep accurate records for each property you service, so you’ll want to be just as precise with those.
Here’s the bottom line: Be clear and honest about business versus personal expenses, and keep good records. The better your record keeping is, the better off you’ll be if you do get audited.
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