A surprising number of people (who file a Schedule C for self-employment, or receive a 1099 MISC from their employer) hesitate to take deductions because they’re heard it will trigger an audit. No one, including tax firms, wants an audit. Here are some of the most common myths and the truths about them.
#1 As a self employed tax payer, if I show my expenses are greater than my income I’ll be audited.
If your expenses exceed your income the result is a loss on your tax return. That’s normal. Businesses don’t always show a profit. Generally speaking, you are allowed to claim all ordinary and necessary business expenses. Be sure the expenses you claim on your return are supported by records and documentation.
#2 I’ll be subject to hobby loss rules if I show losses when I start up my business.
It’s common to experience losses in the early years of a business. If you’re in business to make a profit then you’ll likely be okay. The hobby loss rule says that if you’re not in an activity with the reasonable intent to make a profit, then your ‘business’ is most likely a hobby. Hobby losses are deductible only to the extent of the business income for the year. Moreover, these deductions aren’t considered business deductions – they’re personal miscellaneous deductions which can only be claimed to the extent that they exceed 2% of your gross adjusted income. To keep things simple, this means with an adjusted gross income (AGI) of $100,000 you are eligible to claim any deductions over $2,000. For example, your deductions add up to $3,500. $1,500 of that amount is deductible, and that’s ONLY if you had business income of $3,500. For businesses in this position it’s basically a wash.
It’s best for small businesses to show a profit three out of five years. If you can’t do that then be prepared to demonstrate that you have a profit motive, that you operate in a business like manner, and you keep good records.
#3 Claiming an office in my home will get me audited.
Again, the short answer is no. Currently more than half of all US businesses in the United States are home based. The IRS doesn’t have the budget or the people to go after that many tax payers. In fact, the IRS actually allows you to deduct your actual expenses or use the IRS simplified method listed below.
#4 The IRS won’t help me.
The IRS has a mission statement that describes their intent to provide top quality service by helping taxpayers understand and meet their tax responsibilities. You can find answers to tax questions for free from the IRS website. They also work with taxpayers on payment plans. Sometimes they’ll accept an offer on what you owe. (that’s a whole different blog post) So in a nutshell, they do help taxpayers.
As the growth of small businesses spirals in the new gig or sharing economy, the IRS is changing and adjusting to meet the demands of a larger number of small business returns. Do your thing, but do it wisely. As always, keep good records and if the deduction seems too good to be true, it probably is.