Many business owners put the stress of getting audited right up there with being accused of a crime – you’re guilty until proven innocent.
Luckily, there are several steps you can take to improve your chances of not getting audited.
And, if one day you open your mailbox to find a notice from the IRS staring back at you, don’t panic. There are steps you can take to get through the process successfully.
Think of audits like your high school algebra teacher checking and grading your homework. Audits are the way the IRS double-checks your work and makes sure you’ve calculated your numbers correctly. Specifically, they’re confirming your business is filing and submitting accurate financials to the government.
There are a lot of factors that determine which businesses get audited and which do not. What many people don’t know is that a significant number of the businesses chosen for audit are selected by a computer at random.
If your business isn’t chosen at random and something in your return is flagged, this still doesn’t mean that your business is doing something wrong. What it does mean is that some part of your tax return was called into question and the IRS wants to see your business records to verify that your return is accurate. Audits of simple discrepancies are often conducted by mail. If the IRS has more serious questions, an agent may want to conduct an in-person interview.
If you filed your tax return correctly to the best of your knowledge, then an audit goes from being scary to just being an annoying inconvenience. Still, no one wants to get audited. Taking steps to make sure your tax returns aren’t flagged is the easiest way to make sure the IRS doesn’t come knocking at your door.
What are the red flags that can trigger an audit:
1. Reporting Less than Your Full Income
It can be tempting to keep side income and other small earnings out when tabulating your total income earned for the year. Saving a little now, however, can cost you much more later.
2. Math Mistakes
Making a mistake when calculating and reporting dollars on a return is a quick way to raise eyebrows. Double and triple-check your math before submitting your return.
3. Claiming Too Many Business Expenses
The IRS considers a business expense one that’s both ordinary and necessary to your business. The rules pertaining to business expense deductions changed significantly in 2018, so it’s a good idea to review the new rules to make sure you’re claiming no more than you should. Today, business expense deductions are one of the biggest red flags for the IRS.
4. Claiming Significant Charitable Contributions
If your business supports a 501(3)c charitable organization, you have every right to take a deduction on your donation. Where companies get into hot water is when they report false donations or don’t have the proper documentation to prove the contribution was made. Keeping receipts is a must here.
5. Home Office Deductions
This is a big one! It’s far too common for small business owners who work out of their homes to make large home office deductions without taking the right steps to qualify. And, the IRS knows it. To deduct home office expenses, you must have an area of your home used strictly for business purposes. Know the rules so you can avoid the headache of a home-based business audit.
Dollar amounts that consistently end in zero and five will also be a red flag for the IRS. If your Schedule C or business expense reports all end in round numbers, the IRS is going to wonder why and likely ask you to verify each dollar amount. Reporting exact numbers is an easy way to not draw attention to your return.
Even if your business is doing everything right and you have the most thorough and accurate tax reporting, you can still get audited. While it’s not likely, be aware of what to do if your business does get targeted for an audit.
If you do receive an IRS audit letter in the mail one day, these are the specific steps you need to take immediately.
1. Review the IRS Letter with a Professional
When your business is chosen for an audit, the IRS will mail you a letter. You typically have 30 days to respond. The first thing you should do after reading the letter is to immediately review it with your accountant.
Be aware that debt from any tax you owe will accrue until your tax audit is resolved. Responding to the IRS as quickly as possible is important and can potentially cost you significantly if you don’t.
2. Collect Copies of Your Financial and Tax Documents
Keeping thorough, organized financial records year-round is the smartest way to manage your small business. And it’s the best way to be prepared should you ever face an audit. If you are audited and are preparing documents to submit to the IRS, compile a summary of these key financial statements and records.
- Income statement
- Expense statement
- Schedule C, if a sole proprietor
- Receipts and other supporting documents
- Any other financial statements that support your business’ financial state
A few general rules here: don’t give the IRS more than it requests, don’t give the IRS less than it requests, and don’t give the IRS original copies of any paperwork. Always make copies.
3. Have a Professional by Your Side
Business owners have the right to representation during an audit by an enrolled agent, an unenrolled preparer who prepared your return, or an attorney or CPA. If your audit is being handled solely through the mail, you should still contact your tax professional for guidance. For an in-person audit, have your tax professional on-site with you.
4. Have Confidence in Your Business’ Tax and Financial Records
Keeping good records throughout the year, filing on time, and meeting regularly with your tax professional or accountant is the best way to safeguard your business from tax scrutiny. When you take these steps and follow the rules the IRS puts out, have confidence that your tax and financial records are in good shape. That way, if you do get audited, you’ll be able to back up your filings and stay in good standing with the IRS.
One of the best ways to stay compliant and up-to-date with IRS rules for small businesses is with the guidance of a SCORE mentor. A SCORE mentor can help you navigate tax law changes and create a plan to manage and document income and expense records throughout the year. Contact a SCORE mentor today.
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Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.