I’m not a tax professional. I’m a small business owner who handles most of my firm’s tax activities and try to make myself aware of current tax law. I’ve been audited by the IRS once, and since I had all my records and receipts, I found the process not too painful. Here are some small business tax deductions that are likely to cause an audit. Business owners should not hesitate to take them, but because they are so widely misunderstood and misused, their presence on a return can draw more scrutiny.
Home office deduction
This often misunderstand deduction is a big audit red flag because it’s so often wrongly used. The basic theory behind the deduction is if you dedicate a specific area of your home to your business, you can deduct the corresponding percentage of your rent or mortgage (and related utilities) as an expense. Many small business owners attempt to deduct their full rent or mortgage or a large portion. IRS rules also say the area must be solely and exclusively dedicated to the business, 24 hours a day, 7 days a week and essentially unusable for general living.
Deducting office and computer equipment
Like with the home office, the rule here is the equipment must be solely used for business. Deducting computers, electronics and other equipment can be a problem unless the business owner can prove their use is exclusively for business use. A shared computer at home would not qualify, a laptop used only by one person would.
Deducting car lease or payments and expenses
This is another complicated area where a tax professional can offer specific advice. To simply the situation, IRS rules say the business use-only rule applies, which means if you only have one car, an allowance must be made for the personal use of it. Sure you might drive to work and business meetings, which qualify as business use, but you also might go to the grocery store or take the kids to school, which does not. Accurate mileage should be recorded as the IRS allows a model where business use is calculated per mile, to produce a total deductible yearly sum. Rules also differ with regards to car leases versus car loans and also change between cars and trucks.
For most large items that are deductible business expenses, there are two ways they can be handled. The purchase price can sometimes be deducted in full the year of purchase, or they can be deducted partially over a series of years, called depreciation. This would include large pieces of machinery, equipment or computers, furniture and even vehicles.
Large deductions leaving little or no real income
People need money to live. If your small business tax return or related personal return shows so many deductions there is little or no income left, and this continues over several years, it can lead to an audit. The examiner will ask how you pay your bills, buy food, pay rent with no income.
Use a professional
Any information in this article should be checked with a tax professional. Tax laws and deductions change each year and working with a reputable CPA is the best way to keep up with the changes and ensure compliance. Resources about small business taxes are available from the Small Business Administration (which has a great overview of tax information on starting a business) and directly from the IRS.
More from this contributor:
The Best Business Advice I Ever Received
How to Fund Your Start Up Business: Tips from a Small Business Owner
Business Advice from a CEO