Each year the IRS publishes their activities in a publication called the Data Book. For the past several years the number one target of audits have been those tax returns with a Schedule C for small business activity. How can Sole Proprietors prepare for a possible audit? Here are some tips.
During an audit, the quickest way to get a business deduction disallowed is to blend your personal bills with those from your business.
As a Sole Proprietor, consider opening a separate checking account and use a separate credit card for business expenses.
Keep a logbook for business miles, as well as business meetings and meals. Include the date, time, subject, and who was present at the meeting.
These two key words are used to qualify legitimate, deductible business expenses per the IRS. "Ordinary" is an expense that is common and accepted in your industry, whereas "necessary" refers to an expense that is helpful and appropriate for your business.
A qualified business activity allows for direct deductibility of appropriate expenses, whereas hobby activity expenses are generally disallowed. There are many facets to this situation, but to stay away from the hobby problem, you need to have a profit motive and active participation in the activity to qualify your activity as a business.
Starting in 2023, the IRS is requiring third-party payment providers to submit 1099-K forms for all activity over $600. This means if you take credit cards or use digital payment tools- like Venmo or Apple Pay- to accept payments from customers, the IRS is going to be looking for your business income on a tax return. So keep good records!
Just because the IRS focuses their audit activities in this area does not mean you should be reluctant to take appropriate deductions. Just be prepared to defend your position with excellent records.
If you would like the peace of mind that comes with knowing your company's books, records, and logs are in order, click here to schedule an appointment with one of Gold Standard's seasoned accountants.
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