Top Tax Return Audit Questions For Self-Employed

Learn The Facts About Audits For Self-Employed Tax Returns

••• utah778 / Getty Images

Everyone wants to avoid a tax return audit, especially those who earn self-employment income. The challenges inherent in keeping organized records and properly using deductions can increase the risk of an IRS audit flag. To protect yourself and your business, consider the answers to these top tax return audit questions for those who are self-employed.

How Many Years Can I Take a Loss on My Home Business Before I Get Flagged for an Audit by the IRS?

There is an IRS rule called the Hobby Loss Rule of Thumb. If a business reports a net profit in at least three out of the five years, it is assumed to be a for-profit business. However, if the business reports a net loss in more than two out of the five years in operation, it is assumed to be a non-profit hobby business.

If you are legitimately trying to make a profit but have run into tough times, if audited you will just need to prove to the IRS the following areas (based on information within the IRS Publication 535):

  • Is your intention to make a profit?
  • Do you depend on that income?
  • If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  • Have you done anything different to increase profits?
  • Do you have expertise in this field?
  • Have you made a profit in similar activities in the past?
  • Is the business profitable sometimes?
  • Is it reasonable to expect a profit in the future?

How Much 1099 Income Can I Receive Without Having to Report It?

None. The IRS requires you to report all of your income, even if it is a payment as little as $20.

The IRS indicates it is a common misconception that if a taxpayer does not receive a Form 1099-MISC or if the income is under $600 per payer, the income is not taxable. There is no minimum amount that a taxpayer may exclude from gross income.

What are the top tax return audit flags for a self-employed business?
Home Office Space Deductions

  • Meals, Travel, Entertainment 
  • Writing Off a Vehicle
  • Consecutive Years of Income Loss (hobby business)
  • Hiring Family
  • Disproportionate Income To Lifestyle

What Is the Percentage That I Will Get Audited?

Based on figures from 2011, figures show that for those making less than $200,000, only 1% can expect an audit. Obviously, your chances to be that 1% are much greater if your return raises an audit red flag.

For those earning more than $1 million annually, your chances of being audited have quickly risen to 12%.

Anyone earning more than $200,000 but less than a million can expect to be audited at around 4%.

What Can I Expect if I Get Audited?

If you have nightmares of an individual in a dark suit with a briefcase showing up at your home to issue you an audit notice, don’t expect that dream to come true. The majority of all audit notices come in the mail. Even more shocking, only 25% of IRS audits actually involve a face-to-face meeting between the taxpayer and an IRS agent. The other 75% are carried out entirely through the mail. Unfortunately, once audited, more than 80% of individuals end up paying additional taxes. This is based on figures from 2010.

Your best protection to survive an IRS audit? Have detailed documentation to back-up all deductions. Keep each year’s tax information, including receipts, in an organized fashion somewhere safe. The last thing you need is your tax documents destroyed due to a natural or man-made disaster.

Disclaimer: I am not a tax specialist or licensed tax attorney. The information provided here should be used as a general guide. For specific questions about your own taxes, please consult a tax specialist or refer to the official IRS publications.