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.

1. 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!
2. 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.
3. 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.

4. Hobby losses. Any losses related to activities that appear to be more pleasure than business will attract extra IRS attention.
5. IRS blacklisted preparers. Make sure you hire an honest tax preparer. What more can we say?
6. Income from a barter-related activity. Although no money is exchanged in the bartering process, the IRS still considers it taxable.
7. Comparative size of deductions to each other. An item that is large in proportion to other deductions will draw more scrutiny.
8. Absolute size. A huge deduction, regardless of the accompanying deductions or the income shown on the return, will require a closer study.
9. 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.
10. 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.”
11. 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.
12. 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.
13. 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!

How Do I Raise Capital to Start My MLM Business?

How Much Does It Cost to Start a MLM Company?

Visit us at www.mlmlegal.com to learn more.

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Although it may not be tax season anymore, networkers should keep taxes in mind all year long, saving their receipts and keeping track of business expenses. If you take your network marketing business seriously, you may qualify for some serious tax advantages that are available to business owners, and in particular, home-based business owners.

That’s the good news. The bad news is that the tax deductions that you may be able to take are shrouded in volumes and volumes of IRS codes, regulations and interpretations that could (and in fact do) keep a small army of tax lawyers and accountants busy for years.

Even though these deductions are often confusing and unclear, it is better to have an understanding of them and take advantage of them rather than to pay more taxes than you need to year after year. With that in mind, consider these first important foundational tax points and take them up with your CPA or qualified tax advisor:

No Hobby Losses, Please!

Remember to be able to take advantage of tax deductions for your network marketing business, it has to be a real business. The IRS says that you can’t deduct business expenses unless you engage in the business on a “for profit” basis – not just as a “hobby business.”

How do you tell the difference? The IRS will look at one of two tests. The first objective test is whether you have made a profit in three out of five years. The second subjective test is whether or not you are prepared to demonstrate that you engage in your business in order to make a profit. Here, the IRS is looking at whether or not you carry on the business in a businesslike manner; the time and effort you put into the activity; whether you depend on income from it; your expertise in the business; how much profit the activity makes in the years it does profit; and other pertinent considerations.

The Home Office Deduction

You can deduct the costs associated with your home office, but be prepared to show how you use it.

Assuming you qualify, you can deduct a share of the expenses related to your entire home, such as mortgage interest, insurance, utility bills, and home repair. That share is based on the size of your office as a percentage of the size of your home. Let’s say you have a 3,000 square foot home, and your office is 300 square feet. That means you could deduct as a home office expense 10 percent of the mortgage interest and other applicable costs relating to your whole house. A depreciation deduction for the business portion of your home also comes into play here.

However, the space must be used regularly and exclusively for business. Second, you must use it for administrative or management activities of the business and you cannot have another fixed location for your business where you conduct substantial administrative or management activities. This can be a tough deduction and one that you should be confident in, because it is one of the “red flags” that has a higher risk of triggering an audit than many other deductions.

Record Keeping – The Name of the Game 

If you talk to our friends at the IRS, they will tell you time and time again that the most important aspect of claiming your expenses and deductions is keeping adequate records. The IRS will suggest that you keep a separate bank account, make a record of all business transactions, and retain all your records. Record keeping and substantiation are particularly important for deductions for travel expenses, entertainment expenses and gift expenses. And, the IRS will always tell you that a receipt is ordinarily the best evidence to prove the amount of expense.

Is It All Worth It?

Should you take advantage of the expenses and deductions in the Internal Revenue Code? Absolutely, they are there for you. And beyond the home, and for another discussion, are ordinary business expenses, travel, entertainment, business gifts, automobiles, computers, furniture, equipment, etc. The IRS will tell you that those expenses and deductions are there for you as long as you don’t abuse them.

For more information on taxes and network marketing, read the article “Taxes and the Network Marketer,” visit our tax page (Internal Revenue Service (IRS) Advises Direct Sellers) or watch the video: What are the Central Tax Issues for MLM?

Visit us at www.mlmlegal.com to learn more.