For businesses filing their taxes, getting audited can actually be a good thing, says Sheila Brandenberg, a New York-based CPA.
“Businesses are generally audited on a pretty regular basis and that's great news for them, because perhaps some deduction or item was missed on their return,” she says. “If they know they’re going to get audited, they’ll have an opportunity to fix it.”
A tax audit involves the IRS or a state tax agent double-checking your business numbers and tax forms to make sure there aren’t any discrepancies. Brandenburg says businesses are chosen at random through a computer lottery to get audited but the chances of getting audited are still small: according to the IRS, taxpayers have a 0.6% chance of being audited. Small businesses have a 0.7% chance of being audited. Large corporations, or those that claim taxable income of $1 million or more for three or more years before the current tax year, are more likely to be audited, with a 7.6% chance, according to IRS data.
RELATED: Take a look at the top tax deductions for self employed:
Top 15 tax deductions for the self-employed
Top 15 tax deductions for the self-employed
1. Self-Employment Tax Deduction – Unfortunately, in the eyes of the IRS, you are both an employer and an employee. Thus, you are responsible for both the employer and employee tax contributions to Medicare and Social Security. Fortunately, 50% of your employment tax payment (effectively your "employer" contribution) is tax deductible.
2. Qualified Business Income (QBI) Deduction – To level the playing field of corporate tax breaks, self-employed taxpayers now have a new deduction that assists small businesses with pass-through income (where individual tax rates apply). Sole proprietorships, partnerships, or S corporations may deduct up to 20% of QBI – although limitations can apply and some term definitions in the code are unclear. This deduction took effect from January 1, 2018, so you will be able to claim it for the first time on your return you file this spring for the 2018 tax year.
3. Home Office Deduction – You can still deduct a home office as long as it is your principal place of business, used on a regular basis, and used for nothing other than business. IRS Publication 587, "Business Use of Your Home" gives details on eligibility and how to calculate your deduction.
4. Retirement Plans – If you use a 401(k), a simplified employee pension (SEP), or some other suitable qualified retirement plan, you can deduct your contributions to that plan. Not only will you score valuable tax deductions, you will also save responsibly for retirement by growing a tax-deferred nest egg. The IRS provides details on calculating contributions and deductions based on your choice of plan.
5. Office Supplies – As long as office supplies (non-capital expenses) are purchased and used only for your business, they may be considered as standard business expenses and deducted.
6. Depreciation – Capital expenses (that have a lifespan greater than one year) may also be deducted through depreciation if they are used to generate income for your business. Depreciation may apply to equipment used for both home and business. For details, see IRS Publication 946, "How to Depreciate Property".
The new tax law raised the depreciation limit to $1 million and the depreciation rate from 50% to 100% on equipment bought and placed into service after September 27, 2017.
7. Educational Expenses – Do you attend seminars related to your business? Do you take continuing education classes or maintain subscriptions and dues in relevant professional societies? If these expenses relate to your profession, they may be deducted.
8. Health Insurance – Health insurance is frequently challenging for the self-employed. You may be able to reduce the burden by deducting premiums for you and your family if you meet the criteria outlined in IRS Publication 535, "Business Expenses."
Note: The new tax law eliminates the penalty for not having health insurance (aka the "Obamacare mandate") from 2019 onwards – but health insurance was still required for tax year 2018, for which you are filing a return this season. Although there is no penalty going forward, we don't recommend forgoing healthcare insurance as a cost-savings exercise.
9. Communication Expenses – Expenses such as Internet and data services may be deducted in whatever proportion relates to your business. Basic local telephone services are not deductible for the first phone line in your home, even if you have a home office. Long-distance business calls on that line are deductible, as are the costs of a separate line used exclusively for business.
10. Other Travel Expenses – Some business travel expenses may be 100% deductible if they occur away from your tax home and are considered "ordinary and necessary". The new tax law has eliminated certain entertainment expenses, but the 50% deduction on food and beverage expenses still applies.
11. Promotional Expenses – Business-related advertising costs from full media promotions all the way down to simple business cards are deductible. Promotional gifts may be deductible as long as they are branded to your business.
12. Bank Fees – If you are careful to separate your business bank account from your personal accounts and maintain a clear line between transactions, you may be able to deduct some bank fees related to your business account.
13. Business-Related Interest Charges – Similarly to bank fees, interest on credit card balances and loans that are strictly related to your business may be deducted. Be sure to keep excellent and thorough records to prove the distinction. The new tax law creates limitations on interest deductions for larger businesses (gross receipts greater than $25 million), but, as a small business, your interest deductions should be unaffected.
14. Mileage – Do you use your car for business purposes? You can either take a standard mileage deduction (54.5 cents per business-related mile for tax year 2018 and 58 cents per mile for 2019) or take a deduction based on actual costs such as fuel, maintenance, licensing, and depreciation. Some public transportation expenses may also be deducted. Be sure to keep the personal and business-related mileage expenses separate, retain all necessary receipts, and keep good records as proof of business use. (See the pattern here?)
15. Contract Labor Costs – You may employ other independent contractors on a contract basis to provide services – for example, contracting with a web developer to create your website. Those expenses are generally deductible. You may also deduct the cost of tax preparation services used for the business-related part of your return.
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Whether an individual or a business, when the IRS plans to conduct an audit, it will send a notice through the mail, requesting necessary documentation: W2s, 1099 forms, invoices, bank statements, and other additional documentation related to your business. It’s rare you will deal with an agent in person: 75% of audits are conducted by mail.
While there is no limit to the number of times you can get audited by the IRS, it’s important to keep good documentation. That way, if you are audited, you should have nothing to worry about, Brandenburg says.
“An audit is nothing to be afraid of or concerned about,” she says. “If you document all of your deductions and your business activity, you’ll be fine.”
A capital gain occurs when you sell something for more than you spent to acquire it. This happens a lot with investments, but it also applies to personal property, such as a car. Every taxpayer should understand these basic facts about capital gains taxes.