The IRS releases its Data Book annually, which details all of its activities. And during the past few years, audits have focused mainly on tax returns with a Schedule C for small business operations. So for sole proprietors, how can you prepare for a potential audit? Here is some advice.

Advice for sole proprietors

• Separate your records. Blending your personal and business expenses is the quickest way to get a rejection for a business deduction. Consider creating a different bank account and using another credit card for company costs as an alternative.
• Retain logs. Maintain a notebook for business meetings, meals, and kilometers traveled. Add the meeting’s date, time, topic, and attendees.
• Think ordinary vs. necessary. The IRS specifies two crucial words that must be used to qualify as legitimate, deductible business expenses:
  • Ordinary: A cost that is standard in your sector
  • Necessary: An expense that is beneficial and appropriate for your business
• It’s a business, not a hobby. Direct deductibility of eligible expenses is permitted for qualified business expenses but not hobby activity expenses. Although there are numerous aspects to this issue, to avoid the hobby dilemma, you must have a profit motive and actively engage in the activity to qualify it as a business.
• The IRS will be aware. The IRS will require third-party payment processors to send 1099-K forms in 2023 for all transactions above $600. The IRS will seek a business tax return if you accept credit cards or other electronic ways of payment from clients. So, keep accurate records!

Prepare for an audit

Please don’t hesitate to claim the proper deductions because the IRS concentrates its audit activity in this area. Be ready to back up your claims with stellar credentials. Contact our RRBB accountants and advisors if you have any questions in the meantime.