Filing a Schedule C income tax form -- the form for reporting self-employment income -- may increase the chances of an audit. If your business brings in more than $100,000, the audit rate is 4 percent, four times higher than the audit rate of the average taxpayer. The IRS knows that self-employment makes it easier to write off personal expenses as business expenses than if you pull down a paycheck. One executive, for example, claimed his luxury yacht as a business charter in order to deduct boating expenses, but the IRS isn't convinced.
Review the rules for business deductions so that you know what your legitimate write-offs are. You can't claim the cost of driving from home to your office as a transportation expense, for example. Nor can you claim you have a home office if you work on business in the middle of the family room.
Write down your actual business expenses and don't pad them. If you own only one car, for instance, the IRS will be suspicious if you claim you use it 100 percent for business. Accountants say a number of self-employed professionals make exactly that claim, and it invites an audit.
Report your income accurately. This is really important if you're in a cash business -- which makes it easy to hide a few bucks here and there -- or you make more than $100,000 a year. If someone at the IRS notices you're living way beyond your claimed income, the auditor may come knocking.
Check your math. If you mess up and under-report your taxable income by 10 percent, the IRS may not believe it was an honest mistake. Even if it's a minor error, once the IRS initiates an audit, it can look into every detail of your tax return to find other possible problems.
Keep records proving every expense you claim. No matter how unusual your tax return, if you can document every detail of your spending, you have a valid defense if an auditor calls.
Items you will need
- Receipts for expenses
- Records of payments
- Schedule C form
- If the IRS decides your self-employment is a hobby rather than a business, you can still deduct expenses from self-employment income, but not from other income. If you've been in business five years and in the red for three of them, you'll have a hard time convincing the IRS you're more than a hobbyist.
- MarketWatch: Seven Tax Audit Red Flags
- Internal Revenue Service: Travel, Entertainment, Gift and Car Expenses
- IRS: Business Use of Your Home
- FindLaw: Avoiding an Income Tax Audit
- Realty Times: Audit Red Flags -- The Ones You Don't Want to Wave
- IRS: Business or Hobby? Answer Has Implications for Deductions