6 IRS Audit Triggers and How to Avoid Them
6 IRS Audit Triggers and How to Avoid Them
The end of the calendar year is approaching, with another tax season around the corner. For real estate agents, this can be a time fraught with worry. Your tax return is probably more complex than your neighbors’ returns. Maybe you haven’t done such a great job of keeping track of your business expenses — or separating them from your personal expenses. Does that make you vulnerable to an IRS audit? It may if you’ve done anything to trigger a warning for the IRS. Here are 6 triggers to avoid:
1. Failure to file quarterly taxes. Very likely, your neighbors’ employer withholds federal, state, and FICA (Social Security and Medicare) taxes for them. It’s your job to set aside the money for your own taxes and pay the IRS (and possibly your state) each quarter. Not paying your quarterly taxes, or payments that are late or too small, can result in penalties and additional interest owed. It can also raise a red flag for the IRS. Use the IRS’s 1040 ES to determine the appropriate amount to withhold.
2. Unreasonable deductions. The IRS knows from experience that sole proprietors aim to minimize their earnings and maximize their deductions. But try to deduct expenses that aren’t necessary for your business -- like declaring the full cost of your backyard pool installation as a business expense -- and you may raise a red flag. Expense only what you legitimately use for your business, and keep current on what the law allows (such as the $25 limit on deductions for business gifts).
3. An unlikely home office deduction. Your home office deduction should be based on the percentage of your home used exclusively for the purpose of conducting your business. This means your dedicated space may not be used for other purposes, such as a TV room for your kids. If you do have a dedicated space, though, you can typically deduct insurance, repairs, real estate tax and utilities. If your home office space is 300 square feet and your entire home is 3,000 square feet, for example, the percentage of the deduction you can take is 10 percent.
You may want to take advantage of the IRS’ new simplified method for home office deductions. This method usually results in fewer errors, thus reducing the chance of an audit.
4. Deductions that seem unlikely for your income level. Too many deductions with too little income is a red flag to the IRS. In fact, in 2014, the percentage rate of audits for those who reported no adjusted gross income was a whopping 5.26 percent compared to the 0.85 percent average, according to an IRS report. Why were there so many audits? When the IRS sees this, they wonder if you have inflated your deductions so that you have no taxable income. You shouldn’t take any deductions that you can’t back up with a receipt. Many agents use receipt capturing phone apps like QuickBooks Self-Employed.
On the same point, don’t inflate your charitable deductions. As with anything your buy for your business, keep records of all receipts for charitable contributions. The IRS has limits on how much you can deduct based on your adjusted gross income, so ensure your reported donations don’t go over the allowable limit.
5. Sloppy mileage reporting. You can deduct actual car expenses or mileage to the extent you use the car for business. Most agents take advantage of the IRS standard mileage rate, a fixed rate that takes into account variable costs of operating a vehicle such as insurance, repairs and depreciation, instead of tracking and deducting actual costs. Beginning Jan. 1, 2015, the standard mileage rates are 57.5 cents per mile for business miles driven, up from 56 cents in 2014. So what triggers an audit in this case? Not tracking your mileage or grossly over-representing it as it relates to your adjusted income. Say you earned $15,000 last year and reported driving 15,000 miles, but this year you earn $10,000 and report driving 40,000 miles. The IRS might flag the deduction. Even if you haven’t been tracking mileage, it’s never too late to start. Consider using an IRS-compliant phone app, such as the mileage tracking feature in QuickBooks Self-Employed.
6. Earning a lot of money. The odds of being audited are low, to be sure. But as your income rises so does your chance of an audit. In 2014, if your income tops $200,000, your chance of being audited doubles from 0.85 percent to 1.75 percent, according to the IRS report. As you earn more income, it’s even more critical for you to keep meticulous records. You may want to hire a tax accountant or use small business software to keep records and claim the allowable deductions. You also may want to talk with a real estate attorney about turning your sole proprietorship into an LLC for tax and liability benefits.