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As a freelancer/self employed/micro business owner in the USA - what are my chances of being audited by the IRS? what factors can increase my chances of being audited and what are those chances? Are there any specific fields of business that are more likely to be audited?
Hello! Thank you for using Wonder to ask about the factors that influence the IRS to audit people who are self-employed. The short answer is that there are a significant amount of risk factors that increase the odds of being audited if you are self-employed. The main reasoning is because the majority of self-employed individuals forget to claim all their income or add excessive deductions. Making too much money each year increases the odds of being audited. If an individual makes over $200,000 a year, there is a 2% chance of being audited. You will find a detailed report and my methodology below!
METHODOLOGY
After searching through academic databases, industry reports, government reports and databases, and trusted media sites, I've determined that we have found a significant amount of information regarding your question. First, we researched information on how many high-risk factors there are for people who are self-employed. Next, we looked into how many hard data figures we could find on those odds. Finally, we added all the recent and relevant information into this request that fully answered your question. You will find a deep dive of my findings below!
FINDINGS
high-risk factors
Kiplinger's website states that in 2016, the IRS audited only 0.70% of all individual returns however, if you wanted to use a Schedule C (profit or loss from a business) to report your profit or losses from a business, the odds of being audited increased. The reason that your odds increase with using the Schedule C is because a majority of "self-employed people sometimes claim excessive deductions and don’t report all of their income". Some larger risk factors that this article describes are deductions for travel, restaurants, and entertainment, making a significant amount of money, not making enough money, claiming home office deductions, claiming 100% use of a vehicle for business, performing large monetary transactions, claiming real-estate losses, and claiming day trading losses. Quickbooks had a list of "7 Tax Audit Triggers for the Self-Employed" and some risks that were not listed in Kiplinger's article included inconsistencies with your income, large donations, and rounded numbers on your tax return. The Simple Dollar states that being self-employed runs a higher risk of being audited because people forget to report all income and add excessive deductions. I used this article to double-check the first statement provided by Kiplinger's article.
The Balance states that the IRS has a Hobby Loss Rule of Thumb. This means that "if a business reports a net profit in at least three out of the five years, it is assumed to be a for-profit business. However, if the business reports a net loss in more than two out of the five years in operation, it is assumed to be a non-profit hobby business". If a business is going through a rough patch and they are audited, they have to prove to the IRS that they intend on making profit, they are depending on their business for income, are the losses beyond the person's control, was an attempt made to increase profits, does the person audited have experience in this selected field, have they made a profit in the past, does the business sometimes create profit, and does it look like there will be projected profit in the near future?
Hard data audit figures
The Washington Post stated that in 2016, the number of audits performed decreased by 16% from 2015. If a person who is self-employed makes more than $200,000 a year, they have a 2% chance of being audited. In 2016, 5.83% of taxpayers that had an income of $1 million or higher were audited.
Mile IQ's website provided useful charts that showed the breakdown of how the risks of being audited varied based on an individual's gross income. If a self-employed individual files under Schedule C, I have included the breakdown of income versus the chance of being audited. If you made between $1 to $25,000, there is a 0.9% chance of being audited. If a person makes between $25,000 to $100,000, there is a 2.4% chance of being audited. Making $100,000 to $200,000, increases the odds to 2.5%, and if an individual makes more than $200,000, there is a 2% of being audited.
Market Watch provided an article in 2016 that had the most recent audit figures based on the numbers from 2014. The IRS Data Book from 2014 stated that if small business owners run their business as an S corporation, LLC, or partnership, rather than a Schedule C, the chance of being audited decreased to 0.4%. In 2014, 92% of Schedule C audits were field audits.
Kiplinger's article provided certain specifics on how to reduce your chances of being audited if you are self-employed. I will provide a brief summary of their tips for you. If you want to write off hotels, restaurants, or entertainment, keep your receipts, especially if they are $75 or higher. To claim a home office deduction, you can claim the amount of space that you use in square feet. The maximum deduction is $1,500. If clients pay in cash, keep in mind that the IRS is notified of transactions that exceed $10,000 if it involves banks, casinos, and car dealers.
CONCLUSION
To wrap it up, after searching through industry reports, academic databases, government reports, and trusted media websites, we have found a significant amount of information regarding your question. In short, the IRS only audited 0.70% of individual returns from 2016. However, the more money you make increases your odds of being audited. In 2016, 5.83% of taxpayers that made $1 million or more were audited. If you are a small business owner, it is important to keep records of all your activities because the majority of self-employed individuals either forget to claim all their earnings or add extra deductions.
Thank you for using Wonder! Please let us know if we can help with any additional research!