What Information Must Self-Employed Taxpayers Provide in an IRS Audit?

 Posted on July 31, 2022 in Tax Audits

The U.S. tax system is complex, and there are a variety of issues that could trigger tax audits by the IRS, potentially leading to penalties. Audits can be a significant area of concern for people who are self-employed or who own small businesses. In these situations, it is important to understand the information that a taxpayer will need to provide to the IRS and the issues that may be raised during an audit.

Audit Information Related to Profits, Losses, Deductions, and Expenses

During an audit, the IRS may request a variety of records or other information that supports the information reported on a tax return. These records may be related to:

• Income - All forms of income that a person earns must be reported to the IRS. It is important for self-employed taxpayers to maintain accurate records of all sources of income. This can sometimes be difficult for those who regularly conduct cash transactions. Large deposits into a bank account or major purchases made using cash may be reviewed by the IRS, and a taxpayer will usually need to provide documentation showing how these amounts were earned.

• Profits and losses - A self-employed person is expected to operate their business with the intention of earning a profit. With a few exceptions, a business that reports a net loss in at least 3 years out of a 5-year period may be considered by the IRS to be a non-profit hobby rather than a for-profit business, and this may affect the owner’s ability to deduct their losses. A taxpayer may need to provide records showing that they intend to operate a for-profit business and that they rely on the business to earn a sufficient income. Records accounting for losses may be provided, and a person may be able to show that these losses involved start-up costs or circumstances that were beyond their control.

• Home office expenses - If a person works out of their home, they will typically be able to deduct certain expenses from their taxes, including utilities, real estate taxes, a certain percentage of rent, insurance, or business-related expenses such as phone or internet service. Alternately, a person may claim a deduction of $5 for every square foot of space in their home used for business purposes, up to a maximum of $1,500. When addressing these expenses during an audit, a self-employed taxpayer may need to provide records showing that expenses were business-related or that space in their home was used exclusively for business purposes.

• Travel and entertainment expenses - An audit may review deductions for expenses related to travel for business purposes, as well as deductions for meals or entertainment expenses that were related to business activities. A taxpayer may need to provide detailed logs justifying their travel expenses or receipts for meals or other expenses.

Contact Our San Jose, CA Tax Audit Attorney for Self-Employed Taxpayers

In addition to the records described above, a person may need to provide multiple other documents and forms of information to the IRS during a tax audit. Understanding the right way to approach an audit can be difficult, but with the proper preparation, a person can meet all of their requirements and take steps to avoid penalties. At John D. Teter Law Offices, we provide representation for small business owners and self-employed individuals during audits, and we can help determine the best ways to resolve these matters as expeditiously as possible. Contact our San Jose small business tax lawyer at 408-866-1810 to learn more about our services.

Sources:

https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center

https://www.irs.gov/businesses/small-businesses-self-employed/audits-records-request

https://www.kiplinger.com/taxes/604179/self-employed-irs-audit-red-flags