Each year, the IRS conducts over 70,000 audits in the United States. These audits can be relatively simple, but they may also involve extensive reviews of an individual's tax records, banking receipts, business finances, and more. Errors on a 1099 miscellaneous tax form can have significant consequences. This guide explores how errors on a 1099 reporting form can lead to a potential audit.
A 1099 form is often used for contract labor. This can include a variety of different types of labor, ranging from an individual running a landscaping company to a high-paid executive consultant for a large firm. Most 1099 contractors work on a contractual basis under a non-employee status. Because of this, they don't qualify for traditional benefits from an employer.
For 1099 contractors, it's important to understand that documentation is required for all deductions. If deductions aren't documented in the context of relevant contract labor, you can significantly increase your risk of an audit.
For example, imagine that you're running a web design firm from your home. As a 1099 contractor, you receive multiple tax forms for each client that has paid you over $600 in the fiscal year. Deductions could include a home office, vehicle expenses, office equipment, elections, internet access costs, and a variety of other costs that are required for your business to operate.
For established businesses, managing these types of deductions usually isn't a problem. However, 1099 contractors who work directly with clients can end up in a situation where their personal finances are intermingled with work finances. This could include, for example, bank accounts that are used for both business expenses and personal expenses.
In this situation, an individual may be at a higher risk of an audit. If deductions exceed more than 30 percent of an individual's total tax liability, he or she may be at an increased risk of an audit.
It's important to remember that there are different classes of audits. For a 1099 contractor earning $40,000 a year, an audit may be as simple as providing banking receipts and financial statements. Individuals making six figures may be required to submit to more extensive auditing. This can include forensic analysis of an individual's accounting practices.
Failure to pay quarterly taxes is also a common reason for an audit. If an individual doesn't pay quarterly taxes, this can trigger an internal IRS audit.
For 1099 contractors, it's important to make sure that 1099 forms are filled out correctly. It's essential to make sure that all financial records can be readily supplied in the event of an audit. If you're concerned about your taxes, it's a good idea to avoid online tax preparation tools. Instead, contact a local tax preparer or accountant for assistant. He or she will be able to help you submit accurate 1099 forms. In addition, a tax accountant can help you prepare for an audit. If you do decide to use online tax preparation tools, it's a good idea to purchase audit protection, if the option is available. Audit protection will provide access to an accountant in the event an individual is audited by the IRS.