Self-Employed and Tax Audits

Starting a Business
Often our tax clients ask us if they should start a side business to reduce tax liability. Our answer is if the sole reason is to reduce taxes, it is a bad idea. For example, if you are employed full time and have a part-time business that reports losses for three consecutive years or more, you risk your “business” being labeled a “hobby” and substantially increasing your chance of being audited. Expect spending ten hours a week baking cakes for restaurants and reporting losses year after year to eventually result in an audit.
The Risks of Filing Schedule C
Business owners not incorporated need to file a Schedule C with their annual returns to claim business deductions. Schedule C reports your gross receipts and business expenses, and limits your tax liability to net profits. Business deductions that you claim must be ordinary and necessary to the running of your business. Among legitimate deductions include employee wages, rent, taxes, insurance, professional services, advertising, travel, utilities, and car use for business purposes. Beware, filing a Schedule C considerably increases the risk of an audit.
Preventing and Surviving Audits and Penalties
• Keep meticulous records of income and expenses. Do not estimate your income or deductions. The IRS considers round numbers a red flag, as it signals guessing rather than accurate reporting.
• Avoid needing to file a Schedule C by incorporating.
• Make estimated tax payments. For the self-employed, the burden is on the taxpayer to make estimated payments quarterly. Failing to make these payments on time may result in penalties. To facilitate payments, you can make them through the Electronic Federal Tax Payment System (EFTPS).
• Know what expenses are legitimately deductible.
• Hire a tax professional to guide you to remain in compliance and to do your tax return.
If you have any questions, you are welcome to contact us. Professional Tax Services is a locally-owned provider serving over 3,500 local residents and businesses. For more information call 661-259-1967 or visit www.scvprotaxservices.com. Through their complimentary EZ2 Thrive program, they provide unlimited free tax planning advice to their clients.