6 Tips to Avoid IRS Audits for Freelancers

No one actually knows for sure what the logic behind the IRS audit red flag is. Over the years, accountants have seen commonalities within their client base and have noticed trends in businesses that seem to be audited more often than others. This article isn’t meant to scare you; it’s meant to encourage you to keep solid books.

Bookkeeping isn’t hard. With the right accounting software it should only take a freelancer 30 minutes or less per week to do.

Be Careful with Deductions

Typically, the IRS’s most common red flag is for the home office deduction. To properly qualify for a home office deduction, your home office space should be your “principal place of business”, and it must be used “regularly and exclusively” for business actions. In simple terms, this means that your home office needs to be the place where you spend most of your time and make the majority of your income.

Additional Resources

• Work From Home? Consider the Home Office Deduction
• Calculating Home Office and Depreciation
• Home Office Deduction Calculator

Keep Business Expenses Reasonable

Expenses that fall under the category of travel and entertainment are inspected with a fine-tooth comb. So be careful with what you claim as a business expenses. Also, if you spend cash, keep receipts. Keeping super solid books includes writing down who you had dinner with, and what business purpose it served, or what was discussed. While it is a pain at the time, you’ll be happy to have that paper trail if you’re ever audited.

Separate Business and Personal

You should have bank accounts for both your personal life and your business life. Keep your spending separated and your books clean. The more you muddy the water between business finances and personal finances, the more difficult things become during an audit and the more audit red flags you’ll raise.

Report All Your Income

Choosing to not report income is the absolute worst thing you can do. It’s worse than browsing the Internet with Explorer 6. It sounds like common sense, but some people are tempted to be dishonest.

Your clients must issue you and the IRS a 1099 when you are paid over $600. This means that the government knows what you were paid on each job. Report the right amount on your taxes to avoid audits and potential jail time.

Side Note: Be sure to double check your W-2 and 1099 forms that your employer(s) give you. Companies have been known to make mistakes on these filings, and their mistake could cost you additional taxes.

S-Corporation Red Flag

In past years, the IRS has begun to target S-corporation and they plan to do so even more in the future. The red flag is when S-corporation owners aren’t on the payroll, and they report over $100k of distributions. Make sure you’re paying yourself a “reasonable salary”. Remember, you can’t just take money from the business as dividends. If you’re totally confused by this, talk to your accountant.

Are You in the Process of Being Audited?

Yikes! Read this: How to Prepare for an Audit.

I realize bookkeeping is not fun, but you’re an adult and a business owner. Pretending to be ignorant of the laws and consequences will not get you a free pass from an audit or paying IRS penalty fees.

The easiest way to find time for bookkeeping is to set a calendar event for Monday morning and knock out all your bookkeeping tasks as quickly as possible so you can get back to making money.

Photo credit: Some rights reserved by robynmac.