Perhaps two of the most dreaded words among freelancers and consultants are “IRS audit.” Studies show that only a small percent of individual tax returns are audited by the accounting arm of the IRS. Though the odds of an audit are slim, with ever-evolving technology, accounting and auditing functions in organizations are likely to grow—and the IRS is no exception.
While there is no foolproof way to protect your tax returns from an IRS audit, you can take precautionary steps to reduce the likelihood of your return being flagged by the agency.
Mistake #1: Filing the Wrong Return
The Internal Revenue Code is extremely complex and can confuse even the most tax-savvy consultant or freelancer. As a result, small business taxpayers often make the common mistake of filing the wrong tax form. In other instances, filers will submit the right form, but for the wrong tax year. Make sure that you’re eligible for whatever deductions you claim, according to the year-end eligibility requirements.
Mistake #2: Ignoring the Math
Don’t rush when completing your individual and business tax returns. Filing your returns may be a pain, but making an innocent math mistake, such as adding up your adjusted gross income, can create a red flag for auditors. Double- and triple-check every line and re-read the instructions if necessary before filling out the necessary information and submitting the final copy.
Mistake #3: Overlooking Tax Credits
As an individual freelancer or consultant, employee credits, such as the Small Business Healthcare Tax Credit and Returning Heroes Tax Credit, may not apply to you. However, one of the most common tax write-offs and commonly cited tax mistakes is failing to correctly claim real estate professional status on tax returns. If you’re a real estate consultant or investor, be sure to attach an election to your tax return to claim this credit before you submit to the IRS. Otherwise, you could potentially be missing out on a substantial refund.
Mistake #4: Missing the April 15 Deadline
Avoid procrastinating so that you’re not in danger of missing the April 15 deadline. Regardless of whether or not you file an extension, you’ll still need to pay whatever you owe by the April 15 date.
Mistake #5: Failing to Collect 1099s from Clients
Like the W-2 Form provided to full-time and part-time employees, your 1099 Form summarizes your year-end earnings for contracting and freelance work. Keep in mind that your client only reports these payments to the IRS if you’ve earned more than $600 worth of work.
Neglecting to declare all income earned during the tax year is a tax mistake that can be avoided by simply contacting your client or the issuer and requesting a mailed copy. Moreover, beware of hiding parts of your income—the IRS will notice. The agency also receives duplicates of all your 1099s and employer W-2s.
Mistake #6: Being Dishonest About Business Tax Deductions
It may be tempting to get creative with claims on your Schedule C (Form 1040). Because the IRS knows that consultants, freelancers and other self-employed workers sometimes stretch the truth on what are truly “ordinary and necessary” expenses to run their businesses, auditors pay particularly close attention to the Schedule C. Before you begin writing off business meals, entertainment costs and other expenses as deductions, ask yourself the following questions:
- Are these small business deductions necessary for performing work or increasing income?
- Are these small business deductions typical for my company’s industry or line of work?
For example, if your “home office” also doubles as your family den and children’s playroom, it won’t qualify for a small business tax deduction. Keep detailed documentation, such as receipts, emails and other paperwork, to prove your activities are business-related rather than entertainment or personal hobbies. You can also include a written statement or other attachments clarifying any claims that may raise a red flag with IRS auditors.
Mistake #7: Neglecting to Plan with Your Tax Advisor
Proactive tax planning and analysis will help minimize your chances of being audited; it’ll also help you identify potential deductions and limit your tax liability. Your accountant may be able to pinpoint loopholes providing additional tax credits that can boost your chances for a generous refund. So remember to meet with your accountant and to meet early.
Fixing Tax Errors
If you do receive an audit notice from the IRS, don’t ignore it. Delaying action on delivering required information will only increase the penalties and fees you owe. Consult your accountant and review your tax return to see where you can provide additional supporting documentation. In addition, familiarize yourself with your rights as a taxpayer and the typical steps of an IRS audit on the IRS website.
If all else fails and you believe the IRS has made an error in its determination, you can also file an appeal with the IRS Appeals Office. Alternatively, contact the SBA’s Office of Ombudsman if you or your business is repeatedly audited or penalized by the IRS or state and local government agencies.