The fifth article in our series about IRS audit red flags focuses on claims about businesses losing money. It’s one thing to have an occasional loss, especially during economic downturns when businesses everywhere are losing money. Rest assured, however, that the IRS knows the current trends of businesses and industries on a local and national level. If something smells rotten in the state of Denmark, or Small Town, USA, they are sure to do enough digging to get to the bottom of the story.
If your dental practice fails to turn a profit for three of the past five years, IRS professionals are going to want more than a little evidence of efforts to turn a profit. It’s a huge red flag to wave and a serious indication that perhaps there are ulterior motives for owning and operating your practice.
And watch out if you claim a business that is really a hobby. The IRS isn’t keen on the idea of taxpayers writing off expenses for their hobby that they label as a “business.”
A start-up business may not make a profit in Year One or perhaps even in Year Two, but when no profit is made in the third year or succeeding years, the IRS will begin to think that this “business” is really a hobby because it is not making money. The IRS offers more insight into the determination of a business or hobby here.
Other things that get extra scrutiny from the IRS for small businesses include putting relatives on the payroll, over-estimating business expenses and using a company car for personal reasons.
In the event that this red flag triggers an audit for you, be sure to keep meticulous financial records. In addition, do other things, such as having business cards and a business license, to demonstrate that you own and operate a real business.
Avoiding these red flags is not always possible, but you can minimize them by giving the IRS fewer flags flying and making your business a less attractive target for their further inspection.