The deadline is nearly here. It’s tax season! Are you’re overjoyed or pulling your hair out? Regardless of your perspective, nothing could rain on your parade more than being audited.
You probably do your best to remain inconspicuous, which is a good thing. But some factors are beyond your control. It’s a fact. The more money you make, the more likely you’ll be audited. Those who are self-employed, like network marketers, have a higher statistical probability of misstating their income and deductions compared to salaried individuals. Of course you’re not going to limit your income or change your business plan in order to decrease the chances of being audited! So we’ve decided to put together a target list of 13 [unlucky] red flags that spark interest from the IRS.
- Business expenses are especially important to direct sellers. Did you know that IRS examiners often refer to home office, business travel, entertainment, and business use of an automobile deductions as the kiss of death? Why is this? Well, these particular deductions are often abused and the IRS knows to scrutinize them closely. Keep strict documentation and proper records and be ready to defend your claims!
- Charitable contributions and casualty and theft losses. Taxpayers who donate property to charities, and taxpayers who have had property stolen or destroyed tend to overvalue it for tax purposes. The best defense to an IRS challenge is to get independent appraisal of higher-priced donated items.
- Bad debts. To claim a debt loss you must show that the debt was legal obligation, such as a contract or loan note, and that
you have tried to collect the debt. This is a suspicious deduction because many people try to claim debts of friends and relatives without satisfying the requirements.
- Hobby losses. Any losses related to activities that appear to be more pleasure than business will attract extra IRS attention.
- IRS blacklisted preparers. Make sure you hire an honest tax preparer. What more can we say?
- Income from a barter-related activity. Although no money is exchanged in the bartering process, the IRS still considers it taxable.
- Comparative size of deductions to each other. An item that is large in proportion to other deductions will draw more scrutiny.
- Absolute size. A huge deduction, regardless of the accompanying deductions or the income shown on the return, will require a closer study.
- Out of character deductions. If you claim a deduction that is “out of character” with the rest of the situation presented on your return, you are more likely to be audited. For instance, if you’re selling local products and are claiming extensive airfare deductions, it might raise some suspicions.
- Mistakes, missing information, or incomplete forms also draws attention. If it seems to be a mistake, the IRS is likely to suspect you of trying to mislead them. Make sure to fill in all the blanks the forms require, even if it’s with a “0,” a “no,” or “not applicable.”
- Misfits. Attempts to fit certain items into categories where they do not belong, in order to take advantage of more favorable provisions, will cause suspicion.
- Linked items. If you claim one deduction, but do not claim another closely related one, the IRS will wonder why. For instance, deductions for property tax and mortgage interest are usually found together (unless your mortgage is completely paid). If one is claimed but not the other, the IRS is likely to notice.
- Comparative to income and geographic area: If you claim more or larger deductions than other taxpayers in the general area with similar incomes, again, the IRS will wonder why and take a closer look.
The fact that these are red flag, target areas is not to say that the deductions are not perfectly legitimate. As long as you can substantiate your deductions, you should not hesitate to claim your deductions. What this target list indicates; however, is that companies and distributors involved in MLM activity should carefully document and support their deductions, write-offs, and business expenses.
And because multilevel marketers are home-oriented and social network-oriented in their businesses, many of their red flag deductions really are expenses; where for the average taxpayer, these types of deductions are usually personal and non-deductible.
If you want to be extra careful and possibly head off confrontation with the IRS, include explanations of any unusual items with your return. If the IRS system flags your return, perhaps an explanation may satisfy the IRS reviewer? It’s worth a shot!
We at MLM Legal wish all the network marketers, party planners, and direct sellers a happy and fruitful tax season!
Why stop here? Learn more about running your own MLM business by watching Attorney Jeff Babener’s videos!
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