4 IRS Red Flags to Avoid

Date: July 31, 2009

Hoping to avoid a visit from an IRS auditor next year? If any of the following red flags apply to you, reconcile them before tax time rolls around.

1. Classifying employees as independent contractors.

A growing class of employee is the permalancer: someone classified as a 1099 contractor, who actually does the majority of his work for one employer. Having permalancers on board makes it seem to the IRS that the employer is trying to avoid payroll taxes, which is one of the more surefire ways to get your business audited. 

How can you tell if your independent contractors should be classified as employees? If they draw full-time incomes from you, work on an on-going rather than contract-to-contract basis and regularly work in house for you, then you have an employee who should have a W-2 form with your company.

2. Questionable write-offs.

Sometimes the line between business and personal expenses might seem a little blurry. For example, you take your family along for a weekend conference. Can you write off their portion of the plane tickets, meals and hotel bill? Unless they were working your conference booth, the answer is no. Even if they did put in some work hours, you still can't write off any leisure expenses for the weekend. If a write-off is questionable as a genuine business expense, then it's best not to try it.

3. Miscellaneous expenses.

According to the Wall Street Journal, a Schedule C with a sum total of miscellaneous expenses in the thousands will make the IRS suspicious. Keeping track of your receipts and classifying expenses throughout the year should keep you from dumping too many write-offs into this catch-all category.

4. Home office deduction.

Taking a deduction for a home office is a widely known audit trigger. Yet some home office deductions are bigger red flags than others. If you take deductions for a commercial workspace as well as a home office, this may catch the attention of the IRS. Even home-based businesses should be careful about accurately claiming the portion of the home used for business, and the subsequent amount of rent or mortgage being deducted. Also be careful about the in-home expenses you write off. For example, your home phone line can't be written off, though a second line installed especially for your business could be.

The best way to ensure you don't raise any red flags with the IRS is to hire a trustworthy accountant. If the accountant you work with encourages you to cheat your write-offs, seems unconcerned with the possibility of audits or simply gives you advice that doesn't sound right, look into hiring someone new. Given the time and expense that an audit would cost, an honest accountant is one person you can't afford not to hire.

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