My firm works with a lot real estate agents and brokers, as well as other Independent contractors. Unfortunately, independent contractors often face higher scrutiny from the IRS due to their unique tax situation. Understanding the common audit triggers can help contractors avoid mistakes that may attract attention. Below are the top audit issues for realtors and other independent contractors to be aware of:
- Large or Unreasonable Business Deductions
- Issue: The IRS may flag deductions that seem excessive for your income level. Commonly scrutinized expenses include vehicle costs, home office deductions, and meals/entertainment.
- Avoid it: Only claim business expenses that are directly related to your work. Keep receipts and detailed records. For home office deductions, ensure the space is used exclusively for business.
- Underreporting Income
- Issue: Independent contractors must report all income, including cash and payments without a Form 1099. The IRS matches income reported with third-party records.
- Avoid it: Keep detailed records of all income sources, including cash payments, checks, and direct deposits.
- Excessive Vehicle Deductions
- Issue: Vehicle deductions are closely scrutinized, especially when personal vehicles are used for business. Misreporting mileage or usage can lead to penalties and is what I find to be the most scrutinized area for most of these taxpayers in an audit.
- Avoid it: Keep an accurate log of business miles, including dates, destinations, and purposes. Consider using a mileage tracking app to simply the process.
- Claiming Business Expenses Inaccurately
- Issue: Claiming personal expenses as business expenses or submitting round number deductions without proper documentation can trigger an audit.
- Avoid it: Keep thorough records for each business-related expense. Ensure all deductions are legitimate and tied directly to your work.
- Claiming Losses Year After Year
- Issue: Consistent business losses can raise doubts about whether your business is a legitimate profit-seeking operation or considered a hobby for IRS purposes.
- Avoid it: Be prepared to prove your business is legitimate by showing your efforts to generate profit, such as marketing and operational changes.
- Late or Missing Tax Filings
- Issue: Contractors who fail to file or file late may attract the IRS’s attention, especially if filings show discrepancies year after year.
- Avoid it: File on time, and if you can’t pay the full amount, set up a payment plan or file for an extension. Keep accurate records to avoid mistakes.
- Claiming Excessive Meals and Entertainment Deductions
- Issue: Large meals or entertainment expenses that don’t appear directly related to business are often flagged.
- Avoid it: Only claim meals or entertainment expenses when directly related to your work. Keep records of the purpose of each meeting and the people involved.
- Not Keeping Proper Documentation
- Issue: Lack of supporting documentation for income or expenses can disallow deductions and increase your tax liability.
- Avoid it: Maintain organized records of all income, expenses, and supporting documents. A good accounting system will help.
Final Tips for Avoiding an Audit:
- Be Consistent: Ensure your returns are consistent year after year, especially for income and deductions. If not, understand why they are not consistent and validate they are accurate.
- Avoid Rounding: Report exact amounts for income and expenses to reduce the risk of appearing inaccurate.
- Seek Professional Help: If you’re unsure about your deductions or your tax situation, consulting a tax professional can help ensure compliance and minimize risk.
By keeping accurate records, understanding IRS guidelines, and taking care with deductions, independent contractors can reduce the likelihood of an audit and ensure they’re fully compliant with tax laws.
If you need professional help in handling an IRS audit or with an experienced tax professional to handle your annual tax filings and planning, give me a call today at (972) 821-1991 or schedule a FREE Consultation at https://jablonskytaxrelief.com
