The last thing a single mom needs is to be targeted by the IRS. Even if you end up owing nothing in extra taxes, the hours spent on defending yourself can drain your energy and steal precious time from your work and family.
Most people will never get audited, but there are certain things that can make the IRS take a closer look at your tax return. That doesn’t mean you should avoid these things – some of them are very good things – but you should be aware, so you can be prepared. The best defense during an audit is proof.
So, ladies, if you really want to avoid a bigger tax bill spiked higher with interest and penalties, courtesy of IRS auditors, you need to know about these 11 red flags in your tax return that could spark their interest…and make sure you have the right back up if any of them apply to you.
- Owning a small business: More single moms than ever are small business owners, I’m proud to say. And while they know how to run their companies, they may not know that the IRS scours the tax returns of small business owners, especially those with mostly cash businesses (like bars and restaurants) or those with big losses reported on their Schedule C. The agency has also been looking into a lot of LLCs and S corporations, fishing for extra revenues. Keep comprehensive records, and hold on to vendor invoices and receipts for at least six years. And if you do have unusual deductions, or very high deductions compared to your income, have an accountant go over the numbers with you before you show up at the IRS office – if you have made a mistake, it’s better to know before you head in.
- Travel and entertainment expenses: This is one of the first areas the IRS looks at when it’s auditing a small business – travel, meals, and entertainment expenses, the kind of costs you incur when wining and dining customers or traveling for business. This can get especially tricky for single moms who bring kids along when they have to travel for work: your expenses can be deducted, but expenses related to your children cannot. That doesn’t mean you should stop traveling to meet with clients and potential clients – it just means you need to carefully document these expenses. There are pretty strict rules for taking these deductions, including detailed records for each expenditure, and an original receipt requirement for any expense greater than $75 for lodging when you travel. As long as you have the proper documentation, don’t be afraid to take these expense deductions – but be aware that you might get called in to substantiate them.
- 100% business use of a car or SUV: The IRS knows that virtually no one uses a business vehicle for strictly business 100% of the time … especially if you don’t own another vehicle. So when you fill out Form 4562, be careful about the percent of business use you claim. This is another place where documentation can make all the difference. Remember, every business-related trip you make is deductible – and if you run your business from home, clock and record your mileage every time you leave the house and drive somewhere for a business reason. Without a detailed mileage log/calendar to back you up, the agent may disallow your deduction.
- Taking the home office deduction: The IRS loves to knock out the home office deduction, and they prevail more often than not. They especially focus in on this when you’re showing a loss on Schedule C or your tax return also includes salary income. But if you really use your home office regularly and exclusively for business (it can’t double as a play room, for example), don’t be afraid to take the deduction.
- Not reporting all of your taxable income correctly: When you’re a single mom, there’s a very good chance you’ll be interrupted – repeatedly – when you’re putting together your tax information. That split attention can lead to typos (if you’re doing your taxes yourself), overlooked tax papers, and other simple mistakes. And the IRS is set up precisely to catch those mistakes. Every W-2 and 1099 you receive is also sent to the IRS. Their computers automatically look for matches between their records and your tax return. If something doesn’t match – like you typed a number incorrectly or left something out – the computers flag it, and the IRS will come to call. And if you happen to get a 1099 or W-2 that isn’t really yours, or that reports the wrong amount of income, contact whoever issued it and have them file a corrected form to avoid the IRS computer mismatch.
- Making more than $200,000 a year: IRS statistics show that the audit rate jumps to 2.6% for people earning at least $200,000 a year (not a bad problem to have) … and soars to about 10% if you make $1 million or more. But less than 1% of people earning less than $200,000 get audited. The reason for this is simple: With more money in the mix, there’s more potential for a big catch. The more extra tax revenue an auditor brings in, the better he looks to his boss.
- Reporting losses in rental properties: Managing rental properties is a great way for single moms to bring in extra money – but the tax rules can be a little complicated if those properties aren’t breaking even or making money. Special rules keep people from deducting losses on rental real estate unless they “actively participate” in the rental activity (like a hands-on landlord) or they’re real estate professionals who meet special active participation requirements. The IRS has begun taking a magnifying glass to rental losses claimed by both groups, looking especially hard at people with W-2 jobs unrelated to real estate. As long as you have all of your documentation – especially related to how involved you are – don’t be afraid to report rental property losses.
- Taking more deductions than expected: The IRS pays a lot of attention to averages, especially when it comes to income levels and itemized deductions. If your Schedule A deductions are higher than the average for your income level, your return could be singled out for audit. That shouldn’t stop you from claiming every legitimate deduction you have. As long as you have all the related paperwork, they won’t get an extra dime out of you.
- Supersized charitable donations: Among the Schedule A deductions, the IRS pays the most attention to charitable donations that seem over the top compared to your income level (remember, they track all those averages). This is an area that hits a lot of single moms, especially those that have to downsize after their divorce and donate a lot of household items to charity. Many moms don’t realize that there’s an extra form to fill out for non-cash donations over $500. And if you donate valuable property (like a car), make sure to get it appraised before you take the deduction.
- A deduction for alimony: Alimony is a tricky thing tax-wise. Technically, it’s deductible to the person paying it, and taxable to the person receiving it – but the details really count. To count as alimony, that has to be spelled out in a legal agreement, which has to include a provision that says the payments stop when the recipient dies. It has to be paid by cash or check directly to the ex-spouse – not to the landlord or electric company, for example. And it does not include child support, which is not taxable at all. If the alimony payments you make or receive meet all the detailed requirements, your ex has to report the same exact amount or both of your returns will be flagged for the mismatch, and you’ll almost certainly get audited.
- Getting an early payout from a retirement account: Single moms often raid their retirement accounts when financial emergencies crop up. And if you’re younger than 59½ when you take money out of your IRA or 401(k), the IRS is paying attention. You’re only allowed to touch that money before retirement age under specific circumstances – and even then there’s a 10% penalty charged (unless you meet certain hardship exceptions) on top of the regular income tax you have to pay on money you took out. A lot of taxpayers get this wrong – and the IRS is ready to pounce.
If any of these potential red flags apply to you, don’t worry, and don’t avoid them. Just be prepared to defend yourself with plenty of documentation, and bring your accountant with you if you get called in to the office. After all, just because the IRS audits your tax returns doesn’t mean you did anything wrong, or that you’ll owe more money. It just means they want to see some backup that proves you didn’t underpay.