Outsourcing projects: is there a threshold on how much I can deduct from taxes (IRS)?

Question

Suppose that:

I have a $10000 project. I subcontract the entire project to a subcontractor and pays that person $9999. This means my net gain (or profit) is $1.

If I submit that info to the IRS when doing taxes, will that trigger an audit?

Is there a money threshold on how much my budget is when subcontracting and/or how much I can deduct subcontracting/outsourcing costs from the gross income (which would be $10000 in this case)?

This question is "in theory". I understand that in practice, that $1 net gain would be taken up by other costs like marketing, etc, but let's just assume none of those extra stuff exist. This is not about how to operate a business or how to optimize the cost of subcontracting. I'm asking this from a tax perspective.

Answer 1

There's no minimum allowed deduction or minimum required profit. If you have a genuine business expense then you are allowed to deduct it, even if you end up with a tax loss (more expenses than revenue).

If you end up with a loss year after year, the IRS may consider to re-characterize your business into a hobby (i.e.: you don't really have an intent to make profit), and then disallow some deductions.

Audits may be random, or may be triggered by some things on your return. Certain deductions (like the home office deduction) are known to be abused and may draw more attention. Certain patterns may draw attention. Certain types of business draw more scrutiny (e.g.: cash-only businesses are more likely to be audited). The IRS also compares your pattern to patterns of other similar business. If your numbers vary significantly from what others are reporting they may want to take a look.

When you subcontract work, you'll need to also certify that you sent 1099s as needed, which then will be matched.

When audited, you'll need to provide proof and documentation for all your expenses and deductions, and if you're found to deduct something that isn't a valid expense you may end up with a penalty, and even potentially a criminal case against you. But as long as you can prove every number on your return, you are completely within your rights deducting anything that is an ordinary and necessary expense for your business.