IRS Audits for Self-Employed Deductions

Keep detailed records in case of an audit.

People who file schedule C -- mostly self-employed persons -- account for $150 billion of the $345 billion that taxpayers cheat the IRS each year, according to ABC News. The large amount of fraud that goes on among the self-employed means the IRS audits them at a much higher rate than most other demographics.

Identification

In 2009, audit rates for individuals with less than $200,000 in income averaged 0.95 percent, according to Market Watch. Audit rates for self-employed persons are usually about quadruple that of a normal filer. This occurs because the self-employed sometimes try to claim personal expenses as business costs by accident or intentionally.

Considerations

Taxpayers should not fear taking any deduction just because they worry about an audit. If you have legitimate expenses and clear evidence they are related to your business, claim them as a business cost. What you need to watch out for is excessively large deductions, for instance, if you claim your home office takes 95 percent of your dwelling and the average office takes up 20 to 30 percent of a home. Each year, the IRS looks at the average for a deduction for a given income bracket. Go above this and the IRS may view your deductions as unreasonable. The IRS does not state what it believes to be an excessive deduction, so tax professionals sometimes calculate the average for their region and use that as a benchmark.

What the IRS looks for in an Audit

If the IRS audits you, it will probably look at your business expenses and try to determine if they were really a personal expense. The self-employed often write-off vehicle costs not related to the business. Large deductions for entertainment expenses, such as tickets for clientele, are another area of concern for the IRS. On items you use for business, consider keeping a personal log of the dates and times of use. Handwritten notes are usually acceptable.

Tip

The IRS has manuals on about 100 specific businesses with a large number of self-employed persons. Contact the IRS Freedom of Information Act Reading Room at [phone] for a copy of one of these manuals. If you know what auditors look for, you can make sure you have ample evidence to back up any deduction claims. WorldWideWeb Tax suggests consulting a CPA if you do not know whether you qualify for a deduction.

References

• ABC News: Smaller Fish to Fry -- IRS Targets Self-Employed
• Market Watch: IRS Audit Triggers and Red Flags -- The 2010 Tax Guide from MarketWatch
• Dyner and Associates P.C.: Beware of Rising IRS Audit Rates
• WorldWideWeb Tax: How to Avoid an IRS audit?
• Nolo: Why the Self-Employed Are Audit Targets