How Can MLM / Network Marketing Business Owners Reduce The Risk Of An IRS Audit?

Network marketing / MLM professionals often ask me “What are my chances of an IRS audit?” Many others ask “If I overpay my income tax, will that make me audit proof?”

First of all, the chances of the IRS selecting your tax return for an audit are very low. Approximately 1% of all taxpayers are audited in one year. However, as a small business owner, you are much more likely to be audited than W-2 earners. In fact, sole proprietorships (the legal entity structure for 80% of MLM businesses) are three times more likely to be audited than W-2 employees.

As you know, one of the great keys to success in network marketing is “never give up.” The good news is that the vast majority of those who stay with your company for 10 years or more reach the top position in the company’s compensation plan. The downside is that the longer you stay in business (any business), the greater the chances that you will be audited at least once. And if irregularities are found, an audit beam can strike more than once! So … let’s see how tax returns are selected for an audit and how you can reduce the risk of it happening to you.

The IRS selects taxpayers for an audit in several ways:

1. Random selection. It sounds like something Darwin invented, but it applies here nonetheless. The IRS simply selects a few companies at random.

2. Directed selection. Certain types of businesses are more likely to be audited than others. The IRS will focus like a laser on certain businesses if experience has shown a high degree of noncompliance with tax laws. In the past, attorneys, car dealerships, and funeral homes, for example, had a target on their back.

3. DIF scores. The IRS uses a computer scoring method, called discriminatory index function indices, to select taxpayers for an audit. This method identifies extraordinary tax deductions, such as excess travel, entertainment, or vehicle expenses.

4. Compliance with documents. If you are typically slow to file (miss filing deadlines), or quick to file amended returns (seeking larger refunds), you may be at greater risk of a tax audit. Serendipitous noncompliance, or inattention to form details, can be like waiving a red flag and yelling “I’m here! Audit me!”

While there isn’t much you can do to avoid the glare of DIF scores or random selection, one thing you can and should do is keep good records. Always carry an appointment book or stopwatch to record your car mileage, travel, and meal / entertainment logs. You should also keep special records of the equipment you use for both business and personal purposes. Computers, cell phones, and vehicles used for both business and personal use are excellent examples; These are called “listed property” and the rules that dictate how much you can deduct for business use require detailed record keeping.

If you are serious about your network marketing business, you should maintain a separate checking account for the business. You should also hire a professional to prepare your tax return. Typically, you will save much more on taxes than you will on tax preparer fees. Tax professionals know the rules, prepare hundreds of returns each year, can lower your tax bill, and help you avoid mistakes that could otherwise lead to an IRS audit.

Will Overpaying Your Income Taxes Make You Audit Proof? Repeat after me: they don’t care. The IRS doesn’t care if you pay the correct amount of taxes, or even if you overpay your taxes. They DO care if you pay less than you owe, and also if you can’t verify the deductions you have claimed on your return. The IRS doesn’t care if you overpay in one area; however, you will receive interest and penalties if you underpay in another area.

In conclusion, the best way to perform a “audit trail” is to properly document your expenses and ensure that you receive good advice from your tax accountant.

Leave a comment

Your email address will not be published. Required fields are marked *