An IRS audit for self-employed taxpayers almost always centers on Schedule C: did you report every dollar of gross receipts, and can you prove each expense you deducted? Freelancers, gig workers, consultants and sole proprietors carry the burden of substantiation, so the outcome often depends less on what you spent and more on what you can document.
If the IRS has already written to you, call (415) 754-0115 to schedule a free consultation before you respond. You can also reach the firm through the contact page.
Why self-employed returns get examined
An employee's income is reported on a W-2 and taxes are withheld before the paycheck arrives. A self-employed person reports both sides of the ledger, and the IRS has far less outside data to check expenses against. That gap is why Schedule C filers are examined more often than wage earners. Common reasons a return is flagged include receipts lower than the 1099-NEC and 1099-K totals, large losses offsetting other income, and expenses that look high for the line of work.
What the examiner tests on an IRS audit of a self-employed return
Gross receipts first
Before looking at expenses, many examiners ask how you tracked income. They may request all business and personal bank statements and total the deposits. Any deposit that is not business income, such as a transfer between your own accounts, a loan, a gift or a refund, needs an explanation. Be ready to walk through the largest unexplained deposits one by one.
Vehicle expenses
Car and truck costs fall under stricter substantiation rules than most expenses. You generally need a record of the date, destination, business purpose and miles for each trip, made at or near the time of the trip. A log rebuilt months later from memory carries less weight, though calendars, invoices and phone location history can help support it.
Home office
The home office deduction requires a space used regularly and exclusively for business, and it must be your principal place of business or a place where you meet clients. A spare room that doubles as a guest room or a corner of the family dining table usually will not qualify. Expect to explain the square footage and how the room is used, and sometimes to provide photos.
Meals, travel and phone
Travel away from home and business meals need records showing who, what, when, where and why. Mixed-use items such as a cell phone or internet service need a reasonable split between business and personal use, with a basis for the split.
When receipts are gone
For many ordinary expenses, courts allow a reasonable estimate when some credible evidence shows the expense was real. That leeway does not apply to vehicle, travel and gift expenses, which is why those items are often the first to be disallowed. Knowing which of your deductions fall into which bucket shapes how you respond.
Preparing your records the right way
Organization makes an examiner's job easier and tends to keep the audit narrow. A useful approach:
- Build a folder for each line of Schedule C that is under question, with a one-page summary on top that ties the total to the return.
- Reconcile deposits to reported income and label every non-income deposit.
- Pull 1099 and 1099-K forms and show how each one was reported.
- Assemble mileage records, calendars and client invoices for vehicle claims.
- Provide only what the letter requests. Extra, unrelated documents can open new issues.
If you discover an error on the return while preparing, whether it helps or hurts you, an attorney can review how it should be addressed before your response goes out.
If the examiner asks for an interview
Field and office examinations of self-employed people usually begin with a conversation about how the business runs: who your customers are, how you get paid, which accounts you use, and how you track expenses. Answer truthfully and briefly, and do not guess. If you do not know an answer, it is fine to say you will check and follow up in writing. Questions about your personal living costs are common, because examiners compare what you spend with what you reported earning. Many people prefer to have a representative attend this interview in their place, which a signed power of attorney generally allows.
Self-employment tax and the bigger picture
Adjustments on Schedule C affect more than income tax. Added net profit also increases self-employment tax, and may affect credits, retirement contributions and California returns, since the Franchise Tax Board generally receives information about federal changes. An audit that looks small on the income tax line can grow once those follow-on effects are added, along with interest and possible penalties.
When to involve counsel
A simple mail request for a few receipts may be manageable on your own. Consider representation when the examiner is reconstructing income from bank deposits, when multiple years are under review, when records are thin, or when you are asked to sit for an interview. The Somal Law Firm, led by attorney Bob Somal, Esq., represents self-employed people and small business owners in Pleasanton, Dublin, Livermore and across the East Bay in IRS audits, disputes and appeals. A lawyer can speak with the examiner on your behalf and help keep the audit focused on the items actually in question.
If the audit results in a balance you cannot pay immediately, our article on what to do if you owe back taxes explains the next steps.
Frequently asked questions
Can the IRS look at my personal bank accounts?
Yes. For self-employed people, personal and business finances often overlap, and examiners commonly request personal statements to confirm that all income was reported.
What if I used a tax preparer who made the mistake?
You remain responsible for the return you signed. A preparer's error may be relevant to whether penalties apply, so keep all communications with your preparer.
Can I disagree with the examiner's findings?
Yes. You can ask to speak with the examiner's manager, request review by the IRS Independent Office of Appeals, and, if needed, petition the Tax Court after a notice of deficiency.
When you call, the firm will ask what the IRS has requested and when your response is due, then book a free consultation to go through your records and options. Call (415) 754-0115 today, or send your details through our contact form.
Attorney Advertising. This article is general legal information for Bay Area residents, not legal advice, and does not create an attorney–client relationship. Every situation is different — please consult a licensed attorney about your specific circumstances.