1. Disproportionate Deductions
Expenses that are unusually high relative to income in your industry may trigger scrutiny. IRS computers compare your Schedule C to statistical norms for your business type. For example, advertising expenses of 50% of gross income would be unusual for most service businesses.
2. Home Office Deductions
Home office claims are frequently examined because the rules are strict and misinterpreted. Ensure your claimed space is used exclusively for business. Mixing personal and business use in the same space disqualifies the deduction for that space.
3. Vehicle Expenses
Claiming 100% business use of a vehicle is unusual and draws attention. Most people use vehicles for some personal purposes. Documenting business vs. personal mileage with a contemporaneous log is essential to defend your deduction percentage.
4. Cash Income Businesses
Businesses that primarily deal in cash—tips, barbers, some contractors—receive additional IRS attention due to underreporting potential. Consistent reporting and bank deposits help verify accuracy of reported income.
5. 1099 Mismatches
The IRS computer system matches 1099 forms to your return. If a 1099-NEC reports $15,000 but Schedule C shows $12,000, you will likely receive a CP2000 notice proposing additional tax. Reconcile discrepancies by obtaining corrected 1099s or maintaining documentation explaining the difference.
6. Round Numbers
Expenses ending in even thousands suggest estimation rather than actual records. Round numbers are statistically unlikely and may indicate lack of documentation. Report actual amounts calculated from receipts and records.
7. Net Losses Year After Year
Consistent business losses may be classified as a hobby rather than a business. To demonstrate profit motive, show business plans, marketing efforts, and actions taken to improve profitability. The IRS presumes profit motive if you show a profit in 3 of 5 consecutive years.