Payroll, shipping, invoicing, client communications â with so much going on a small business often starts to feel like a three-ring circus, and as the owner or manager of a small business, you might feel like the overworked ringleader. One aspect of owning a small business that can strike fear into an ownerâs heart is being pinged by the IRS for an audit.
As a small business owner, the chances of your taxes being audited by the IRS are relatively low. According to the IRS, only about 1 percent of personal taxpayers are audited, but small business owners have a slightly higher chance of facing an audit i.e. about 2.5 percent. There are various ways small business owners can trigger an audit, from simple mathematical mistakes to fudging your numbers to posting losses in multiple years. Here are some of the biggest mistakes small businesses owners can make on their taxes that may trigger a tax audit and how you can steer clear of these mistakes.
Exorbitant Claims
Many business owners like to regularlymeet clients face-to-face, and this might include the occasional dinner or cup of coffee. The IRS is very strict on claiming this type of deduction, so before you add it to your return, read up carefully on the guidelines. As a rule of thumb, you can deduct 50 percent of your business-related meal and entertainment expenses, including the cost of food, beverages, taxes and tips. Also allowed are any activities considered to provide entertainment, including nightclubs, sporting clubs, theaters, sporting events or vacations.
You are unable to deduct club dues or membership fees, fees for use of entertainment facilities (including any you own and for which you pay maintenance fees) and out-of-pocket expenses. Additionally, some gifts are deductible, but no more than $25 for business gifts per person during a tax year.
Steer Clear Tip: Keep your receipts with detailed notes on each entertainment event or meal you deduct. Make sure you note the business purpose, a description of the event and the business relationship. If you have your notes in order, you can easily present them and avoid an audit for your small business.
Home Office Claims
Many small businesses owners, especially those who work the majority of their hours from their home or work virtually, think they can deduct their home office. Others may be tempted to stretch their definition of a home office. While the IRS encourages you to consider the Home Office Deduction, they are rather strict on the definition of a home office.
According to the IRS, your home can be considered a home office if part or your home is used exclusively or regularly as your principal place of business, as a place to meet clients or customers or any area not attached to your home (i.e. a separate structure on your property) that is used for business. Special rules apply for day-care facilities and home offices used to store business inventory or product. The amount you can deduct depends on what percentage of your home is used.
The terms âexclusivelyâ and âregularlyâ are the key. An extra room or study with a desk, bookshelves, and other office âequipmentâ used specifically for work â and rarely if ever for personal use â qualifies. A desk in your living room where you set up shop a few days a week does not.
Steer Clear Tip: Read the IRS rules very, very carefully before considering the Home Office Deduction. If youâre not sure, contact a tax expert or donât take the deduction.
Reporting More Losses Than Profits
Self-employed small business owners likely must fill out the Profit or Loss from Business (Sole Proprietorship) form, otherwise known as the Schedule C. This form reports what you made or lost in your business in the tax year.  Any type of business can be reported on the Schedule C except for farming and rental activities, and is calculated by taking the income from all sources and subtracting business expenses for a net profit or loss for the business.
You never expect a loss for your business, but in this economy, it happens. However, if you report losses three out of five years, itâs a red flag for an IRS audit, and they may determine your business is a hobby and your Schedule C loss will be disallowed.
Steer Clear Tip: Make sure you keep documents, receipts and detailed notes for your business and conduct it in a business-like manner. The burden of proof is on you to prove your business is legitimately a business and not just a hobby. If youâre losing money year after year, talk with a tax professional.
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