Schedule C Audit Triggers: What You Need to Know

If you own your own business, there are Schedule C audit triggers you need to know. Schedule C is the tax form used by sole proprietors to report their business’s profit and loss to the IRS. It is frequently audited because statistically, there tend to be more problems with taxpayers under-reporting income and over-reporting deductions, particularly in cash-intensive businesses such as restaurants, gas stations, dry cleaners, and others. To avoid an audit, it is important to understand some of the most common audit red flags. If you are still audited, consult a tax lawyer to help you present a strong case to the IRS and negotiate a favorable settlement if needed.

What Are Common Schedule C Audit Triggers?

Certain situations are more likely to trigger an audit. These include:

1. Higher than expected meals, travel, and entertainment deductions. The IRS will consider what is typical for your type of business or profession. If you fall outside that range, auditors will request detailed documentation.
2. Gross income of $100,000 or more. Your odds of an audit increase significantly if you make over $100,000 so make sure your recordkeeping is meticulous.
3. Several years of consecutive large losses. If your business reports large losses in consecutive years, the IRS will question how the business can continue to be a going concern and/or whether it is a hobby, rather than an actual business.
4. Home office deduction. Covid resulted in more people than ever before trying to claim home office deductions. However, to succeed, you must use a designated area of your home exclusively and regularly as your principal place of business. It cannot be used for other purposes, even when you are “off-duty.”
5. Exclusive business use of a vehicle. Trying to claim that you only use your car for business is difficult to prove because there are bound to be times you drive it for personal reasons even when you have other cars. It’s best to keep receipts and documentation of every trip.
6. Unreported income. The IRS will scrutinize cash-intensive businesses more thoroughly to identify unreported income. In addition, all businesses are subject to data analysis and data sharing across jurisdictions. The IRS and states will share pertinent information about individuals and businesses and utilize statistical tools to identify tax returns for audit.

Regardless of the type or size of your company, the IRS will compare the business’s revenue and deductions to similar businesses. If your income or deductions are outside the norm, it may increase your chances of an audit.

How Can You Avoid an Audit?

While you may not avoid an audit in all circumstances, to minimize your risks, take these steps:

1. Educate yourself or hire a tax professional to advise you regarding what records you must keep and deductions you are entitled to take.
2. Keep detailed records of your revenue and expenses so that if you are audited, you can substantiate your tax return.
3. Review your tax return thoroughly to ensure there are no mistakes.
4. When in doubt, get tax advice before submitting your return if you didn’t hire a tax professional at the outset.

What Should You Do If You Get Audited?

Assuming you didn’t make a mistake you can easily rectify, consult a tax attorney for advice. Challenging an audit can be complicated and there are serious consequences if you miss deadlines or make errors in your paperwork. A tax lawyer can assist you in determining the most effective way to resolve your tax problem and work with auditors on your behalf so you don’t have to worry about it.

If you have received notice of an audit or collection action, contact us for a consultation.