SIX RED FLAGS:

How to keep your tax return from flagging the attention of the IRS

by Joe Mullich, National Federation of Independent Business

Want to avoid an audit? Watch out for these red flags that will likely draw scrutiny from the IRS.

1. DON'T be a rounder. Be careful about deductions with a lot of neat zeros, such as advertising, $10,000; business mileage, 12,000 miles; insurance, $5,000. “The odds are that advertising will be $9,937, and business mileage will be 12,362,” says Patrick Astre, an enrolled agent and author of This Is Not Your Parents’ Retirement. “Too many improbable round numbers tell the IRS this business owner has not been keeping records as required and is making up numbers.”

2. DON'T be miscellaneous. A large number of deductions reported as “miscellaneous” may suggest that records and receipts weren't kept properly. “In my practice, I never use the category “miscellaneous,” Astre says.

3. DO separate your business and personal finances. “Commingling funds is a red flag for the IRS,” says Bernard Bandish, executive vice president for tax resolution firm JK Harris & Company in North Charleston, S.C. “Your business could end up being classified as a hobby with serious tax consequences.”

4. DO be careful if you rent your office. The IRS looks closely at anyone who owns a schedule C business, pays rent and also receives rent income on schedule E, notes David Rachford, CPA and president of Rachford & Company in Santa Barbara, Calif. The problem? If the schedule C company is paying rent to the owner or the owner’s spouse, it’s not OK to pay rent in order to lower self-employment income. “If you want to lower self-employment income, consider using a corporate entity structure like an S-corp,” Rachford says. “Properly structured, the corporation is a separate legal entity and may pay rent to an individual.”

5. DO pay officers enough. Stanley Foodman, a Miami-based forensic accountant, says to beware of unreasonably low officer salaries in S corporations or management fees in place of officer salaries in C corporations. “While there is no hard-and-fast rule here, we suggest that 50 percent of profits before considering officer salaries is probably a good number as a starting point,” he says.

6. DON'T deviate from normal deductions. Home office, mileage and business-lunch deductions pique the IRS’s interest. The agency keeps a range of normal deductions for specific tax brackets and types of businesses, says Ralph Havens, an enrolled agent and the director of licensed taxpayer representatives at JK Harris & Company. “If you deduct $5,000 for business lunches, but the average for your tax bracket is $1,500, expect a call from the IRS.”

© 2015 TLC Magazine Online, Inc.