Running a small business is hard enough without taxes complicating everything. Even if you do your best to file accurately and on time, there’s still a chance you could face an audit. And IRS audits for small business owners are no joke. You can’t stop an audit once it has started and the audit penalties can be brutal. So, what can you do? If you learn about the following small business tax audit triggers, your chances of avoiding them in the future should be much higher.
Here are some common small business tax audit triggers:
Believe it or not, the IRS notices when you file late, especially if you continue to file late annually. And with those late tax returns, they’re more likely to turn a more inquisitive eye to what you’re reporting and why.
The fix here is simple: file on time. We know it’s not always that easy. But timely filing can help keep you out of the IRS’s crosshairs, assuming nothing else catches their eye on your return.
Overdoing it with deductions
We know how important deductions are to a small business owner. And there’s nothing wrong with claiming certain deductions, like the new 20% pass-through deduction. The problem instead lies with trying to claim every deduction that might work for you. Higher than normal meal expenses and claiming your car as 100% business use are big indicators to the IRS that something’s amiss.
And don’t get too comfortable with the simplified method that was announced in 2013 when it comes to the home office deduction. The filing method may be easier, but the requirements are still very complex.
The part of your house that can be claimed must be solely dedicated to your business. This means that if you use some square footage of your home office for personal reasons, the whole room won’t qualify, just the part used for business. When the requirements for a deduction are this complex, trust that the IRS is keeping a serious eye on anyone who claims it.
There are two things to keep in mind when claiming deductions:
- You’ll want to be consistent year-over-year with your deductions.
Keep in mind the IRS’s “ordinary and necessary” rule when it comes to deductions. If the expense can be considered both ordinary and necessary to your business and to others in your line of business, you should be able to defend claiming it as a deduction. Those expenses shouldn’t change drastically from year to year.
- You don’t want to claim deductions that are out of proportion with your taxable income.
The IRS has their ways of determining how many deductions are too many for individuals in varying income brackets. If you’re claiming deductions that are way too high for your business’s income range, the IRS may come sniffing around. Stay prepared by keeping detailed records of any deductions that look uneven.
Reporting consistent business losses
Have you reported net losses over the past few years? According to the IRS (and most small business owners), the purpose of a business is to earn money. When the IRS notices a business not earning money year after year, they’ll perk up.
If your business is a startup and it takes a loss in its first year, your chance of being audited is lower. And if you earn a profit from your business for three of every five years, you’re likely in the clear.
However, if you only earn a profit from two of five years in business, the IRS may audit you. They’ll want to find out if your business is actually a business or just a hobby.
This trigger is a particularly vital one if you have a sole proprietorship, as it can make your audit risk skyrocket. Sole proprietorships are particularly susceptible to mixing personal and business expenses.
Having large cash transactions
Let’s face the fact: Cash is harder to track than credit card transactions and checks. Businesses that deal in large cash transactions are often at risk in the IRS’s eyes of underreporting and therefore not paying enough taxes.
Maintain good records of your cash transactions to ensure you can show your own detailed tracking of cash coming through your business. You’ll also want to file Form 8300 if your business accepts any cash payments over $10,000. At the end of the day, documentation makes a huge difference when you find yourself amid a tax audit.
Rounding numbers and messy math
We know you learned in school to round up when calculating final numbers. But that’s not the best route to take when filling out your tax forms.
You don’t want to report your income as $85,000 if you made $85,025.63 that year. Perfect numbers can stand out to an auditor. Of course, if you made $85,000 perfectly, report that exact number. Be sure you have the records to prove it down to the cent.
Also, if what you report on your return doesn’t align with your business records, don’t assume the IRS won’t notice. The IRS is as serious about math as your eighth-grade algebra teacher, so they will double check the calculations on your returns. And if something doesn’t line up, they’ll be sure to track down the cause.
The best way to avoid a small business tax audit:
Knowing these major audit red flags will help you avoid them in the future. Keeping detailed and extensive records of your expenses and transactions can also be a lifesaver.
However, sometimes it’s the least common audit trigger that can catch you in an audit trap. If you want to avoid a small business tax audit, seek out a trusted tax professional.
Tax pros like ours are well-versed in tax law and know what serious small business tax audit triggers to avoid. They have experience in filing small business taxes to maximize your deductions and minimize your chances of a tax audit.
If something does happen and you find yourself with an audit notice, we’ve got your back. Our tax experts have experience in tax audit help and dealing with small business tax issues. We make sure you’re never alone in dealing with the IRS.