There are many different types of seasons. For accountants, after tax season comes IRS Audit season. Auditors will review every type of taxpayer from Individual to Business. Historically, the IRS has selected a higher percentage of sole proprietor – schedule C – filers for audit followed by Limited Liability Companies, and then Corporations.

Business owners that may know most of the rules may not necessarily comply with all of them or seem to miss a few, similar to everyday driving. Almost all drivers will stop at stop signs but maybe not follow the speed limit exactly.


Auditors are really fun people sometimes. They know the books and they know the rules.  Auditor backgrounds vary just the same as all people vary.  We have met auditors who have never had a non-government job. They studied auditing at school and began working for the IRS after graduating. No actual independent business experience. Another auditor we met was a retired military drill sergeant. Someone who is really good at enforcing rules but no real grasp of what goes on in the sole-proprietor business world.

Auditors have rules and tests they apply. The Revenue test is a very common test that uncovers large awkward adjustments. It applies to any business as it ties together 1099 reports, credit card machine reports, and deposits in banks.


Bank accounts with any circulation of monies between other accounts (personal or business) may find that the deposits have a much bigger number than the revenue posted on the tax return. Very common since not all of the deposits were revenue based. This test will pick up all of your revenue based on what went through the account with no need to take any amounts out where we as taxpayers may have had a transfer of funds. Taxpayers are responsible for proving to the auditor where the money came from if it is not business revenue or it will remain included as revenue.

About half of an IRS auditor’s time can be spent going through an entire year of bank statements and credit card statements. Perhaps funds were taken out, held for a few days, and then put back in to the account. That deposit would count as revenue in the eyes of an auditor even thought the taxpayer would see it as replacing existing funds. Taxpayers are going to pay tax on deposits that are not really revenue.  It’s easy to have anywhere from $20,000 to $100,000 of deposit money not accounted for.  That’s a large amount to be off.

Paypal reports can now cause a double entry. Paypal is required to issue 1099-K to anyone who sells $20,000 or more.  Plus if you are receiving over $600 from one person, that person is required to send you a 1099 as well.  These overlapping 1099’s bring up an IRS red flag for under reporting revenue.


Receipts are important. Today, many individuals and businesses are going paperless. Electronic records are difficult to retrieve as time passes. Bank statements and Credit Card statements show that an item was purchased but it does not show what the item was. An IRS rule makes it necessary to show evidence of exact purchase or the deduction does not qualify. If evidence is vague or missing, the deduction will likely not be allowed. Auditors do not have to prove the deduction does not qualify. It is solely the taxpayer’s responsibility to provide evidence for all deductions posted on their tax return.


Business owners should have a separate phone to properly take the telephone deduction – one phone for personal and one for business. The same applies with the internet. The actual applicable deduction covers long distance charges that are business related. Most phones have unlimited or all included long distance which then cancels the phone as a qualified deduction unless it is on a separate invoice.


Receipts are required. Keep the receipts and make them one step better by writing on the receipt who you saw and what the business purpose was. The deduction can be taken away if details are not kept. Auditors know to look for little details. They don’t want to give the taxpayer the business trip write-off unless it is well documented.  Without clear evidence the deductions can be removed.  Generally, Prospecting new business transactions does not qualify as a travel deduction. The deduction will qualify if the travel expense occurs while visiting a client you have received business income from.

Auto usage is another tricky area for business owners.  Auto mileage deduction calculations are supposed to declare a personal use percentage.  Taxpayers do not get a full car write-off unless there is a well documented mileage log.

Sole proprietors are required to issue 1099’s to document expense purchases over $600 unless the business is a corporation. A 1099 should be issued to landlords for rent payments and to Lawyers for all services.  Technically, unless there is a 1099 issued, the write-off may not be allowed.


Audits are usually a three (3) year cycle. Auditors can require change in all 3 years if they catch costly situations.



Steven Z. Freeman, CPA provides Tax Planning, Business Accounting,  plus IRS representation and can assist you with these services. If you have any questions on this matter, or to schedule an initial consultation, Please call us at (805) 495-4211.

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