Sole Proprietors Targeted

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Sole Proprietors are Likely Audit Targets

Sole proprietors, independent contractors, self-employed workers, freelancers and others accounted for $68 billion in missing taxes, the Internal Revenue Service said.

“That is a very significant noncompliance rate,” the Internal Revenue Service Commissioner told reporters. “We do not have specific conclusions as to how much of this is willful or confusion.”

Sole proprietors are at least 10 times more likely to be audited this year than other business entities. Last year, with more enforcement personnel available, the Internal Revenue Service audited almost twice as many individuals as five years previously.

Professionals advise sole proprietors to consider making their businesses corporations or LLCs to avoid audits and to hire an Enrolled Agent (EA) or a Certified Public Accountant (CPA) for tax advice. Before a business owner jumps to a business form other than "sole proprietor", there are some considerations to think about. Business owners should review the consequences of such moves with their qualified professional.

What are the red flags the Internal Revenue Service will be looking for in sole proprietor returns? Underpayment of quarterly estimated payments, or late payments, could be significant to the Internal Revenue Service. Sole proprietors should also watch their income-to-deduction ratio. If this ratio exceeds 52 percent, an individual is more likely to be audited. Finally, beware of the home office deduction – a prime Internal Revenue Service deduction, avoid vague expense categories, such as "miscellaneous", also avoid numbers on the return that are too round, such as $9,000 vs. $9,100.

An Internal Revenue Service spokesman was asked what red flags the agency looks for and “how it determines who would get audited.”

The spokesman said that common errors that tip off the bureau are invalid or incorrect Social Security numbers for the filer or dependents, math errors, and incorrect bank deposit numbers or routing numbers. Returns will get special attention when the taxpayer fails to sign and date the return or fails to attach W-2s when required.

Generally the Internal Revenue Service assigns a numeric score “somewhat like a credit rating” to each return, and thereby determines which returns will require more review. But “the major reason of all audits is illegal tax shelter,"  “or the use of offshore credit cards.” “Sometimes the Internal Revenue Service looks at an industry and if you work in that industry you might be audited.”

Returns prepared by computer and e-filed are neat and less likely to have math errors experts agree. Taxpayers should prepare their returns early, but should not file early.

The Internal Revenue Service advised using only reputable tax preparers, those who have the title “enrolled agent” meaning that they’ve taken a qualifying test from the Internal Revenue Service.


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