If you are self-employed, you enjoy a range of freedoms that aren’t standard for W-2 employees. But you may also face higher scrutiny from the IRS, potentially increasing the risk of an audit.
While the IRS typically audits less than 1% of individual returns, you shouldn’t discount this possibility. Ensuring the accuracy of your tax returns and preparing for an audit are important steps in protecting yourself against penalties.
Learn what you need to know about IRS audits for self-employed individuals.
Common Red Flags That Trigger an Audit for Self-Employed Individuals
If you are self-employed and file Schedule C with Form 1040, certain actions might increase the chances of an audit. The IRS considers these “red flags” that occasionally indicate a person is being untruthful on their tax returns:
- Claiming large amounts of self-employment income
- Claiming large business expense deductions, credits, or losses that are disproportionate to your income
- Reporting inconsistent income compared to the information in bank statements or from payment processors
- Having high volumes of unreported cash income, or reporting cash income that is disproportionate to the nature of your industry
- Claiming that you use a vehicle 100% for business purposes
- Reporting large losses on rental property
- Using rounded or repetitive numbers instead of reporting actual costs
- Claiming the research and development (R&D) credit
- Claiming home office deductions without evidence
Meeting any of these IRS audit triggers won’t guarantee that you will face an audit, but it should prompt you to prepare for the possibility of one.
How To Prepare for a Potential Audit as a Self-Employed Individual
Continually preparing for an IRS audit for self-employed individuals helps you face this potential IRS action with confidence. Follow these tips to prepare your self-employed business for an audit:
- Follow strong recordkeeping practices: The IRS audits self-employed individuals to ensure that they have reported income, deductions, and expenses correctly. Following a robust recordkeeping system ensures that you have evidence for all of your tax claims. Create a system where you organize financial records by tax year so that you can easily find tax documentation when you need it. This may involve using accounting software to simplify your recordkeeping process and maintain easily accessible digital files.
- Keep receipts and supporting documents: You should have receipts or other evidence to back up all deductions. For vehicle expenses, get into the habit of maintaining a mileage log. Organize bank statements, invoices, and canceled checks to support your tax return figures and give you easy access to evidence if you face an IRS audit for self-employed individuals.
- Double-check all figures and avoid estimates: Avoid rounding figures to the nearest hundred; instead, take care to track and report all figures accurately.
- Pay estimated taxes and file on time: Self-employed individuals are generally required to pay estimated quarterly taxes. Be sure to make these payments and file annual returns on time to stay compliant with the IRS.
- Work with a tax professional: Filing your self-employed tax returns with the help of a CPA can lower your chances of being audited and improve your chances of success if you do face an audit. Your tax professional will help you ensure accurate reporting and maintain records of your tax documentation.
Levy & Associates, Inc., Helps Self-Employed Individuals Maintain IRS Compliance
Facing an IRS audit for self-employed individuals can feel scary, but the right preparation can reduce your chances of being audited and ensure that your finances are in order if you are. Levy & Associates, Inc., helps self-employed clients file their tax returns, maximize deductions, and face audits with confidence.
Contact us today at 800-829-5389 or fill out our contact form to request a consultation.
