Enjoy gambling but can’t get to Vegas? Let’s look at the odds of your business incurring an IRS audit. Most equine businesses are classified for tax entity purposes as a type of flow-through entity (the income/loss from the business flows directly through to the owner’s personal tax return). Sole Proprietors file either a Schedule C or F, partnerships a 1065 and Subchapter S corporations an 1120S. Because the income/loss flows directly to the owner’s return, that has recently become the increasing focus of the IRS audit efforts. Looking at data for 2011, one out of every 90 returns was audited. Those are pretty good odds against audit for the average taxpayer. But there are factors that cause the IRS to increase their scrutiny of a return:
1.For taxpayers with incomes of $1 million or more, one in every 8 returns was audited.
2.For taxpayers with incomes of $200K or more, one out of every 25 returns was audited.
- The income totals included all income, not just business income.
Other red flags for IRS audits include:
3.Claiming 100% use of a business vehicle. If you truly use your vehicle (not including farm vehicles such as tractors, etc) 100% for business, you need to have substantive documentation of the use. You need to keep a daily log of your business trips including beginning and ending mileage and business purpose (e.g. - drove to Mary Smith’s to teach riding lesson). Also be sure to check the box on your return that you have another vehicle available for personal use.
4.Having a business that involves a lot of cash transactions. Again, documentation is key. You should keep a bank account that is solely for your business use and make sure that all your business income is deposited to that account.
5.If your deductions are higher than usual or average. The IRS tracks the average percentage for many types of taxable deductions (e.g. donations, miscellaneous expense, meals and entertainment, etc.). Even if your deductions are legitimate, be aware that a deduction that is unusual for your situation or your type of business can trigger an audit. So you want to include as much information in the return as possible to document the situation. For example, if you incurred significant damage from a weather event, rather than including those expenses in the line item “Repairs and Maintenance”, you might want to add a line for “Hurricane Sandy related repairs and maintenance”.
6.Claiming a home office deduction. Be very careful on this one. You need to be able to document exclusive and regular use of the space for your business , which is very difficult to prove. If you do have a space that qualifies, then you should consider the deduction. But be aware that it is another hot button for the IRS.
7.Hobby vs business. Hobby activities can only claim expenses to the extent of income so they are not allowed losses – which can be used to offset income from other sources. So the IRS is laser focused on any business that can be construed as a hobby.
If you have more than one of these situations in your business, the odds of being audited increase dramatically. If you want to hedge your bets, assume that you will be audited and act accordingly. Hire someone knowledgeable to keep your books and prepare your tax returns. Get good advice before taking action on anything that might have tax consequences. And keep extensive documentation of every business expense you claim on your return.
You may have higher odds of being audited than you’d have on the slots in Vegas. But Vegas is a lot more fun than an audit.