This post has been a long time coming as I got the idea last spring when HOUSE of HARPER was audited.  Being the only employee (at the time), when my time was pulled away from running my own business to deal with the audit it was one of the most stressful times I can remember.  I vowed to share everything I learned along the way with anyone who wanted to listen to prevent anyone else from going through the lengthy process of having to get your ‘case’ in order for the IRS.

Before anyone panics on my behalf, I should preface with everything turned out fine.  But, time is money and my audit cost me A LOT of my precious time.  I will elaborate more on my personal experience in the questions below.  But first…

We are thrilled to have private practice attorney Sara F. Hawkins share her professional insights with you all today. Sara, a seasoned attorney with 20 years of practice, works with entrepreneurs, startups, bloggers, marketing and advertising agencies, and major corporations.  (Whenever we need a contract or legal advice, Sara is our girl!)

We rounded up your questions from Instagram and our own and asked Sara to help us prepare for another year of taxes. We think you’ll find her expertise as helpful as we do!

Since I just shared that I have been audited, let’s start with everyone’s biggest fear.  What tips do you suggests for preventing an audit? Any red flags the IRS looks for that we should avoid?

CK: Since I am sure you are all wondering what triggered my audit, I’ll jump in with my personal experience.  When we were filing our 2015 taxes (spring of 2016), I was staying up late the day before they were due to get all my business expenses together for my husband.  (Tip #1: Don’t wait until the last minute!)  I categorize my expenses for him and sent them off late that night.  The next morning when I went to check what I had sent, it was only my most recent credit card #. (I got a new card about half way through the year because I lost my old one and the statements were broken up by card #.)  This meant that I had not attached half of my legitimate business expenses and therefore he had not included them in our write offs.  Since our taxes were filed before I caught my mistake we decided to file an amendment.  Our (now) accountant thinks the amendment of almost doubling our write offs caused a red flag and therefore our audit.  I’ll share more tips from our experience as we get into the questions below.

SH: Whether you do your taxes yourself or use an accountant or tax preparer, there are a few items that seems to raise the risk of an audit. Keep in mind that there are a number of different types of audits. When people think of an IRS audit they likely think about having an IRS agent pouring over their return line by line asking questions about every item. However, many audits are paper audits which means that something didn’t match up in the IRS system and more information is needed. Some of the items that raise the risk of an audit are:

1. Home Office Deduction – The home office deduction is looked at with greater scrutiny because people don’t realize there are very specific rules. The key determinant for taking the Home Office deduction is that the space must be used exclusively for trade or business. Using a guest bedroom, dining room area, or part of the den as the home office would disqualify that deduction. If the space is used for personal use at any time, taking the deduction isn’t in your best interest. In addition, taking a Home Office deduction while also reporting wages will increase the likelihood of an audit.

2. Failing to report all taxable income – This should come as no surprise, but sometimes it happens innocently. Not everyone who underreports their income is willfully trying to cheat on their taxes. The IRS does not have agents scouring social media looking to see what people do so they can audit them. The IRS has computer-based algorithms that look for inconsistencies. If income drops significantly but expenses do not, the return may be flagged. But the main reason a return will get flagged for under-reporting income is based on missing or incorrectly entered information from W-2s or 1099s. As a blogger, there are often numerous 1099s that need to be entered. If an agency or brand files a 1099 with the IRS but you don’t receive it for some reason or you receive it late and had already filed your taxes, your return may be flagged because your reported 1099s does not match up with what the IRS is expecting. Of course this is easily explainable, especially if you included the income on another line, but it could still trigger an audit.

3. Claiming high deductions – Some businesses have more expenses than others, and blogging or running an online business is no different. An editorial blogger will likely not have the same level of expenses that a food or craft blogger will have. A travel writer may have greater deductions than a social media consultant; it’s just the nature of the business. Regardless of the type of business, if the deductions are disproportionate to what the IRS algorithms expect, the return may be selected for audit. But just because you have high deductions doesn’t mean you’ve done anything wrong. If you have support for every deduction and they are all qualified deductions, the audit is more of an inconvenience than a reason for concern.

4. Typos and Math Errors – This may seem obvious, but simple math errors will get a tax return flagged for review. This may not be as much of a concern if you’re using tax preparation software, but mistakes happen. Always double check the math. It’s easy to transpose numbers or put numbers in the wrong place, and software will only be as accurate as the information it has to work with. And while it’s unlikely there is a glitch in the software, many errors can be found just by double checking the return before filing.

What tips do you have for staying organized and preparing for your taxes?

SH: I’m often asked this question and I feel like I fumble with the answer because I tell people to create a system that works for them. Quickbooks or other accounting software programs work for some, but not for all. What it comes down to is if the person will actually use it. If you’re a paper and pencil person, then a notebook will be your best system. But at some point, as your business grows, you’ll likely need to look into something more efficient.

While not every business can get a separate credit card, and using a debit or cash only method may not be feasible, if you’re running a business you need a way to keep your business expenses separate from your personal expenses. If you have to use the same credit card, keep the business charges separate from your personal charge by making multiple transactions, if necessary. As a travel blogger, if a portion of your hotel stay is for business ask to have the transaction separated so you can track the business-related expense more easily. If you’re a food blogger, do your best to separate your business-related food purchases from those you make for your family. For makeup bloggers, keep your personal purchases separate and, if needed, create a marking system to know which items are personal and which are business.

With fewer purchases being made with cash, it’s easier to keep track of them without tossing scraps of paper into a shoe box. However, it still takes time and diligence since the IRS requires that you must have receipts for transactions over $75. Many credit card companies now allow users to add comments to their online statements, but you need to take the time to do that on a regular basis. When making online purchases, the emailed receipt can be easily filed by simply forwarding that email to yourself with a short explanation or comment and filing it in its own email folder.

Ultimately, though, the best system is one that you’re willing to do.

CK:  One of the most painful and time consuming parts of my audit was getting everything to the IRS in paper form.  In today’s day and age, everything is online, but when our auditor required everything on paper.  So my new system may seem old school, but I prefer knowing if it ever happens again I can just hand over my binders and not lose any sleep.  This could also be adapted to email or dropbox folders.`

I now have a binder filing system in my office.  I have a contract binder where I print every contract with brand and they are filed alphabetically.  During the audit if I had a receipt for a project for anything from flowers to an airline ticket, I had to show proof why I needed that expense.  My contracts served as this proof.  I also keep binders for each fiscal year with all the financial documents I need.  I have sections for my invoices for work completed, 1099’s for contract workers filed with their w9 and invoices to me, bank statements, tax forms, etc.  I also keep accordion folders by year for receipts, also alphabetical, so if I was asked for proof of a hotel expense, for example, I could quickly get my hands on the receipt. Most of the time receipts just go from my purse to the front of the folder, but a few times a quarter we file them in their proper place to keep up with it.  (Note, you also have to write on the receipt who was there and what was the business purpose.  Ex. Lunch with Sarah Hawkins to discuss tax blog post)  This was the biggest challenge with my audit because I literally had unorganized shoe boxes of receipts from the years and I had to go back and organize them all, write on them and file them.  I also had to print all my brand contracts, bank statements, etc. that I had always stored electronically.  Again, it wasn’t that I was hiding anything it was just getting everything together that was so time consuming.  Blogging is also a very new business so trying to explain to our auditor why I was styling a table for a holiday shoot or why my family took a trip to San Francisco for a baby stroller company was a huge challenge in and of itself.

For other Bloggers reading this, can you tell us about acceptable write offs?

SH: Expenses related to goods and services ‘ordinary and necessary’ for your business and exclusively for your business may be deductible. For goods or services that have both a business and personal use, only the business use portion may be deducted. For bloggers, online content creators, influencers, and online entrepreneurs it can be challenging to determine what is a business-related expense and what is a personal expense because often there are overlaps.

Clearly, some expenses are easily designated as business expenses. Your domain name registration and hosting fees for your business-related blog or website are an example. If you hire an SEO consultant or use a virtual assistant to maximize your online business those are purely business expenses.

However, the cost of a new phone or tablet may be a hybrid business and personal expense if you are not using the device solely for your business. Same with a camera and camera equipment. If you’re buying a new lens but also use that lens for pictures of your family or for personal photographs you’ll need to determine which portion of that use is related to your business.

For bloggers and online influencers there are unique expenses that may be business expenses though the general classification is seen as personal. Also, depending on the type of blog you have or influencer you are the expenses may be very different.

A fashion or makeup blogger/influencer may have legitimate business needs for wardrobe, hair, makeup, and other expenses for manicures, facials, or waxing while a craft or DIY-blogger likely will not. However, while it’s difficult to calculate the personal-use portion of something like a blowout, facial, or professional makeup application if you are undertaking those expenses for photos or videos for your business it will be important to keep documentation such as an editorial calendar, business calendar, or sponsored post contracts to demonstrate they were for your business. Remember that if audited the IRS representative may have no idea about your work and the general understanding of personal care such as hair, makeup, and nails is that those are not business expenses for most businesses.

Where a food blogger may have high food-related expenses, not all bloggers will. And while a food blogger may have higher than normal food costs, an IRS auditor can question what you do with all that food because most people don’t know that food bloggers don’t actually eat all the food they make. In fact, a food blogger may be giving away food to their kid’s school or to local friends for any number of reasons.

With photography and video becoming key aspects of growing or sustaining your online business, upgrades to equipment, props, lighting, and editing software are all very important purchases. However, as with all expenses, the question is what portion is attributed to business use versus personal use. Few people buy just 2 plates, but a food blogger will. The average woman may not spend the money to try out the newest styling tools, but a hair and makeup blogger definitely would. A tech blogger will certainly purchase the newest phone, tablet, or smart-device, but if they continue to use it for personal use or give it to their spouse or child when they’re done they’ll need to capture the business use only. As you can see, there is no one answer to the “Is this deductible?” question.

The unique nature of blogging is something to keep in mind when documenting your expenses. While the expenses may seem self-explanatory to you and your other blogging friends, to an outsider it may just look like you’re redecorating your house, going out to dinner, taking a fancy trip, or buying your kids the latest technology.

Here are some common expense related to blogging or running an online business:

• Home Office (see the discussion above)
• Studio or co-working space – talk with your accountant or tax professional to make sure you’re eligible
• Hosting fees
• Internet service
• Skype, Google Voice, or VoIP fees
• Phone, computer, other technology
• Themes, Plugins, or Apps for your site
• Website design
• SEO, Pinterest, or Social Media services
• Analytics software
• Photography or videography equipment and software
• Conferences – registration, travel, meals (there may be some limitations)
• Business travel
• Legal and accounting fees
• Banking and credit card fees
• Accounting software
• Independent contractors
• Advertising fees
• Business insurance
• Education (ex: webinars, online courses, local classes)
• Office supplies (ex: pens, paper, folders, printer)
• Postage and shipping

And, of course, there are the expenses that are uniquely associated with your business that don’t fit into a traditional category.

What proof do you legally have to have for write offs? Is a credit card statement ever enough or do you legally have to have an itemized receipt?

SH: Generally, a business is required to keep documentary evidence, such as receipts, canceled checks, or payment confirmations to track business expenses. There are exceptions, however. The IRS requires receipts for any expensed item of $75 or more, but of course the IRS reserve the right to request documentation for any amount in the event of an audit.

For all expenses you need to capture (a) the amount of the expense, (b) the date the expense was made, (c) the place the expense was made, and (d) the essential character or purpose of the expense. For meals and entertainment expenses, you also need to list the people involved. While it may seem easy just to keep a receipt and add a notation, many receipts today are printed on thermal paper and could eventually end up just being blank pieces of paper. The IRS does accept digital records, so it’s important to consider using cloud storage solutions, document the information in a spreadsheet, or use an expense tracking app to capture the information soon after the expense was made.

Thanks to technology it’s easy to file away your business records. The IRS rule for document retention is 3 years from the tax return deadline date. So even if you file your 2017 tax return early, if your tax return is due April 15, 2018 the 3 year time period would end April 15, 2021. Of course, this is the IRS so there are exceptions to this 3-year rule for items such as employee tax records, disposition of property, unreported income, bad debt write-offs, as well as other more unique circumstances.

Why is having a seperate business credit card so important?

SH: If you’re running a business you should, at minimum, have a separate bank account for the business. It’s the best way to track income and expenses. In addition, if you are anything other than a sole proprietor having separate accounts keeps you from co-mingling funds and risking becoming personally liable for business matters. If you can’t get a separate credit card for your business, at the very least keep one personal card solely for business expenses. While using a personal card for your business expenses exposes you to personal liability for your business, if there were to be questions about the legitimacy of your business you would have more solid arguments.

How do you suggest estimating and preparing quarterly taxes?

SH: As a business owner with variable income, the paying of taxes is often a challenge to figure out. Unlike getting a paycheck where taxes are withheld by the employer, the business may be responsible for paying quarterly taxes. The IRS doesn’t like to wait for its money. If you use an accountant, tax preparer, or tax preparation software you may know that you need to pay estimated quarterly taxes. The easiest way to collect that money is to put aside a portion of each payment received so when time comes to pay you’re not caught off guard.

You can find Sara online at her website or on Twitter and Instagram at @sarafhawkins.