Vital Details for Independent Contractors Facing a Tax Audit

Tax Audit

Taxpayers file tax returns according to their current classification. For example, if an individual completes work for clients, they have the option to incorporate as a business, or they could file as an independent contractor. As an independent contractor, the individual must collect 1099-MISC forms from all clients that hire them. These forms are not the same as W-2 tax forms that are provided by a direct employer because the companies hired the individual to complete work as a contractor and not a compensated employee. Independent contractors must review tax laws to determine how to file their taxes and avoid a tax audit.

Your Income Must Match All Tax Forms

As an independent contractor, the taxpayer receives a 1099-MISC from companies that hire them as a contractor. Their wages are as non-employee compensation. When completing a tax return, the taxpayer must report their income from each 1099-MISC form they receive. The totals on the tax forms must match the calculations on the tax forms. If they audit the individual, the IRS calculates all income listed on the 1099 forms. The IRS could require additional tax payments if the taxpayer didn’t report all their income. The independent contractor needs all their tax returns listed on the notification when hiring an attorney to help them.

Tax Audit

Deduct Expenses That Pertain to Your Business Only

For independent contractors, it’s vital for them to turn to tax preparation services if they are unsure about tax deductions. Business-related deductions present independent contractors with issues that could lead to an audit. For example, they cannot claim a portion of their home as a business expense if they do not use the room for business only. For instance, even if the taxpayer completes their work in their living room, they cannot claim it as a business deduction because they use the space for other reasons. A home-based business can claim space inside their home if they use it for business purposes, and they have clients that visit them at home.

What are Common Triggers for an IRS Audit?

As an independent contractor, the business owner must become familiar with common issues that trigger a tax audit. If the individual claims expensive items they purchase for non-business-related reasons, they cannot deduct it from their taxes. For the IRS, this is a red flag.

If the taxpayer deducts travel expenses, they must have evidence that the expenses were related to operating their business. For example, they cannot deduct the cost of their gas unless the individual used the gas to go see a client or to perform services. They cannot deduct the cost of any meals unless they purchased the meals for clients.

Independent contractors could deduct some expenses for business attire if they meet with clients regularly. However, the IRS will audit them if they make under $30,000 a year, and they purchased high-end designer clothing as business attire. It’s not tax deductible, and the IRS auditor could penalize the taxpayer for the deduction.

Failing to File a Tax Return

Tax laws require all individuals that earn at least $600 a year to file a tax return. However, as an independent contractor, the IRS will expect the taxpayer to file a tax return even if they earned less than $600. The IRS views independent contractors as business owners, and they must report all business earnings, even if the taxpayer generated less than $600 for the year.

The IRS could start an audit if an independent contractor stops submitting tax returns suddenly. For example, if they have a steady history of submitting tax returns, it is a red flag to the IRS if the taxpayer doesn’t file. If the independent contractor didn’t earn any money for that year, they can explain this to the IRS if they are audited.

How to Respond to the Tax Audit

The independent contractor must respond to the IRS’s audit notification within 30 days. They have the option to submit all requested tax returns and records via mail. However, if the individual needs legal help with the audit, they can hire an attorney. The attorney could manage the tax audit on the taxpayer’s behalf. The attorney could schedule manage the audit through the mail or schedule an in-person interview. They tell the taxpayer what forms are necessary and offer advice about how to answer the IRS’s questions.

Keeping Accurate Records Helps

The business owner needs accurate records for their business earnings and expenses. If they keep accurate records, the tax audit won’t become overwhelming. The IRS recommends keeping tax forms for at least ten years. This helps the taxpayer access their records quickly, and it’s easier to comply with the IRS’s orders if they don’t have to search for the tax records. Attorneys recommend sending a copy of the tax forms instead of the originals. If the taxpayer used a tax preparation service, they could contact their tax service to get copies of any tax returns they don’t have.

Why Does the IRS Audit Independent Contractors?

The purpose of a tax audit is to determine if the individual paid all their taxes correctly. An assessment of their tax returns determines if the contractor or their tax service completed the returns incorrectly. The IRS conducts the audit to ensure that the taxpayer is not guilty of tax fraud or tax evasion. They want to assess the forms and establish that all income was reported correctly. If any inconsistencies arise, the IRS will render a judgment to collect outstanding tax payments.

Independent contractors must file a tax return and report their earnings on 1099-MISC forms. They must calculate their earnings correctly and ensure accurate calculations when filing. If there are any errors, the individual could face a tax audit. Common triggers for a tax audit are sudden increases in company profits, odd tax deductions, and inflated deductions for items that weren’t related to the business. If the contractor doesn’t file a tax return, the IRS could flag the taxpayer and start a tax audit, too. Independent contractors discuss tax audits and issues with an attorney to avoid serious repercussions of a tax audit.

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