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Five Red Flags on Your Tax Return

Published on Apr 8, 2015

Red Flags on Your Tax Return Marcia Richards Suelzer, MA, JD Less than one percent of returns were audited by the IRS in 2014, and that percentage is likely to be even lower this year due to budget cuts. However, it still is wise to make sure your returns are as accurate as possible. This is particularly true if you own your own business. Business owners are more likely to find their income tax returns under scrutiny than those who have only wage income from an unrelated employer. Why? Because the IRS has computerized matching programs that can easily tie Form W-2 wages to a specific tax return, making it harder to hid income. Plus, employee deductions are also severely limited, making it harder to lower the tax bills by inflating expenses. On the other hand, business owners have a greater ability to underreport income and overstate deductions because simple matching programs can’t verify the accuracy of many of the reported numbers. As a result, a tax return with a Schedule C (Business Expenses) or Schedule E (Supplemental Income) is more likely to catch the eye of an IRS employee. Here are xxx items that are hot buttons on a tax return.
  1. Failing to report all income from all sources. The IRS is especially wary of cash-intensive businesses, such as restaurants and beauty salons. During an audit, the Service will “reconstruct” your income using a variety of methods.
  2. Paying yourself (or your family members) unreasonable salaries. It is perfectly legal—and usually wise—to reduce your overall tax bill by paying yourself a salary from your corporation.  And, other family members can be on the payroll as well. However, the salaries paid must be reasonable for your area, industry, level of expertise and the amount of work done.
  3. Claiming an excessive amount for business meals, travel and entertainment. Whether an amount is excessive depends upon your location and type of business. But, all meal, travel and entertainment expenses must be for a business purpose and substantiated with detailed records.
  4. Inflating the amount of business use. Many types of property, such as cars and computers, can be used for both business and personal use. If you have mixed-use property, makes sure you accurately estimate the extent of your personal use.
  5. Inaccurate reporting of rental income and expenses. Schedule E (Supplemental Income) items likely to pique the IRS's curiosity are improperly computing depreciation expenses and improperly applying the passive activity loss and at-risk rules.
It’s smart to make sure you claim every deduction and credit that you can. However, inflating expenses or ignoring income can prove to be costly. So, protect yourself. Know the rules for claiming the deductions and don't try to game the system. And, make sure you have the documentation required by the rules, well-organized and easily accessible if you are audited.