With millions of small business owners, freelancers, and sole proprietors doing their own taxes every year, there are bound to be some honest mistakes. The tax code is so confusing, and most likely, you didn’t go into business to be an accountant (unless you are an accountant), not to mention there’s clearly an incentive to try to go overdo deductions.
However, you have to fight these impulses—even if you’ve snuck by with inaccurate deductions before, you don’t want to get into a tussle with the Internal Revenue Service. If the IRS suspects fraudulent behavior, not only can they audit you for the current year, but they can audit you for several years back if it wishes—jail time is even a possibility.
Here’s what you can do if you suspect you’ve mistakenly deducted a personal expense as a business expense.
Ordinary and Necessary
The IRS has a simple definition of what makes up a business expense—it has to be “ordinary” and “necessary.”
“To be deductible, a business expense must be both ordinary and necessary,” the IRS says. “An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
The easiest rule of thumb is to look at all of your company’s expenses and ensure they fall under this rubric. Is it a normal expense considering your industry, and is it essential for your business?
Personal Versus Business Expenses
With this broad definition, it can be easy to consider pretty much anything ordinary and necessary for your business. However, you should research each specific deduction to ensure you are doing it correctly. Many purchases, like new business clothes and commuting mileage, are considered personal expenses, not business deductions.
Filing an Amended Return
Hopefully, if you are using tax preparation software, any mistakes are flagged to be corrected before you file. Additionally, many options will predict how likely your return will trigger an audit due to inconsistencies.
If you made a mistake on your return but you’ve already filed your taxes, you can file an amended tax return. In many cases, this will be Form 1040-X, the Amended Individual Income Tax Return, but it might be different depending on how your business is structured.
The deadline for filing an amended return is 3 years from the date you originally filed. Unfortunately, you can only file Form 1040-X through the mail, not electronically.
The IRS Will Notice Errors, But Might Launch an Audit
The IRS will also contact you if they notice a math error or deduction issue. They might ask for documentation regarding an expense. The IRS might just reject the deduction and ask you to pay more tax (plus a penalty).
In the worst-case scenario, the IRS will audit you. This possibility is why it is best to pay close attention to your deductions before you file.