Around tax season, it’s normal to have deductions on our minds. Most of the time, it’s one of the more beneficial parts of filing taxes, but there are several tax write-offs that raise red flags for the IRS if they’re done incorrectly. It’s important to know your way around your small business deductions so that you can be certain that you’re doing everything in your power to take advantage of deductions you’re entitled to without causing yourself any headaches. Here are several tax write-offs to avoid due to their risk of leading to an audit. This doesn’t mean that you should completely neglect these write-offs, just avoid claiming them incorrectly or without justification.
High Salaries for Shareholders/Employees
When you own a business and you have shareholders that are also listed as employees, you have to be careful with how much you pay them. This can be said for both S and C corporation businesses. Unreasonably high salaries paid to shareholders look suspicious on paper. Be sure to study the appropriate compensation for shareholders based on your business’s income, especially if those shareholders are also employees. These payments might seem like they’re a good idea when it comes to filing taxes, but they increase your tax deduction audit risk if they don’t look right in the eyes of the IRS.
If you’re claiming too many deductions or the total of your deductions appears to be much higher than what’s common for your income level, the IRS might decide to have a look at your records. For example, if you’re claiming deductions by way of charitable donation that are nearly ¼ of your business’s income, it’s going to likely raise some questions and the government might want to see some documentation that proves you’re not trying to take advantage of the system. Significant charitable donations might make you feel like you’ve done a good thing when you’re claiming your deductions, but if they seem like they’re not aligned properly with your income, you may have some explaining to do.
Unreimbursed Expenses for Employees
If you’re entitled to this deduction, it’s reasonable to claim it, but be aware that this kind of deduction brings about the attention of the IRS. While it’s common for employers to reimburse their employees or expenses that the employee has paid, it is still looked at somewhat closely because of incorrect reporting. Remember, unreimbursed expenses are only deductible if they have exceeded 2% of your gross adjusted income for the year.
There are many expenses that qualify for this deduction, but be sure to ask your tax professional about those that you plan on claiming to be certain that you’re allowed to claim them. With the help of someone who knows their way around business tax, you can be sure to claim deductions you’re entitled to without doing so in a way that isn’t deemed correct.
Improper Cash Records
If you’re deducting anything that has to do with cash transactions, make sure that you have your calculations correct because the IRS has a formula that suggests to them how much a business should have in cash sales based on their credit card transactions. If something doesn’t add up, you’re going to have a problem. Claiming cash income isn’t something that goes without records. This means that you can’t simply claim a certain sum of cash without being able to back up your claims with receipts. There’s a chance that you can slip by without receiving an audit for this action alone, but there’s no way that you won’t at least draw attention to yourself, and the IRS will definitely keep a closer eye on your business from that point on. Mistakes or failure to report correctly will eventually be called into question.
Suspicious Deductions Increase Your Tax Deduction Audit Risk
If you’re claiming write-offs for your business that don’t appear to be related to your work, you might increase your tax deduction audit risk. The IRS pays attention to small business deductions and if they don’t appear to have any benefit to your business, you might need to establish proof that these purchases were made for work-related activities. Be prepared to explain yourself and offer proof if you’re purchasing children’s toys and you do not run a child-related business, or if you’ve just purchased a home theater system and your work has nothing to do with the entertainment industry. Mixing business and pleasure are usually trouble when it comes to taxes.
If you have employees working for your business but you have them categorized as contractors, you are very likely to receive a tax audit. Business owners have attempted to do this as a way to get out of paying benefits to workers and to claim independent contractor pay on their tax returns. It’s not a wise move in the long-run, and the IRS is not going to overlook it. It’s in your interest to be certain which type of workers you have and report them legally to avoid any problems.
If you have not calculated your taxes and your deductions properly by accident, the IRS doesn’t care. Tax time is no time to get sloppy because a deduction mistake can still bring about a tax audit. Be extremely careful when it comes to your filing, your claims, and everything else related to your taxes. Check your receipts, invoices, and your books. Double-check all of your math and have a second set of eyes look over your work for you. If something doesn’t add up, fix it before you file, or the IRS is certainly going to notice and you may very well incur more of a tax deduction audit risk.
Though there certainly are tax deductions for your small business that you should keep away from if you’re not entitled to them, there are ways to go about your deductions safely without having to avoid them completely. Any attempt at falsehood will never be to your benefit when it comes to the government so it’s good to stay on the safe side and ask your tax professional if you have any questions about your tax deductions.
If you’re in the market for a reputable tax firm, consider West Austin Tax for your income tax questions and services. You can visit their website for information, video resources, or to schedule an appointment with one of their professional CPAs. You can also call (512) 330-9400 for more support.
*West Austin Tax is not a CPA firm.