Nothing is worse than getting that certified letter from the IRS telling you that you’re being audited, and if you’re running a small business it can feel like the hammer of doom. While there is no tried and true method of avoiding an audit, there are a few things you can do to improve your chance of avoiding an audit.
Yes, this might seem somewhat obvious, but the IRS really hates bad math. If you have a large number of errors in your return, that’s a huge red flag that will land your return in the “needs an audit” pile. If you’re filing your own returns instead of hiring a professional, check your math again and again. And again.
Filing Schedule C
If you’re a small business or a sole proprietor and aren’t incorporated, you have to file a Schedule C return—and the IRS tends to scrutinizes Schedule C filers just a little bit more. If you’re still filing Schedule C after being in business for a while, you definitely might want to consider either incorporating or forming an LLC for your business for a little extra padding in avoiding an audit.
Too Many Deductions
Did you know one of the major red flags for the IRS is the home office deduction? If you claim this deduction, you need to be sure you have a room in your home that is 100 percent used for work. So no, that computer in the corner of the kid’s playroom doesn’t cut it as a home office. But that’s only one of the many deductions that can flag your return; large travel and entertainment expenses can also be an issue, as can auto deductions.
Reporting a Net Loss For Three Years
The IRS wants to see a profit for at least two out of five years a business is in business. If you report a net loss for three years within a five year period, the IRS flags you for a possible audit—and worse, they’ll classify your business as a hobby and you’ll lose all of your deductions. The IRS uses a “profit motive” test to determine if your business is really a business. So consider reeling in those deductions if they show a net loss.
Salaries That Are Too High & Too Many Contractors
If you pay salaries that are too high, that raises a few IRS eyebrows. Salaries aren’t taxable income, and if your company’s income is going primarily to high salaries for staff (particularly staff that are also stakeholders in the company), you’re likely to trigger an audit. In addition, if you don’t have any employees and are relying heavily on contractors, that also triggers the IRS for audits. Balance both sides of the coin here carefully.
While avoiding these mistakes can help, you also might want to consider working closely with a tax professional to prepare your filing. Not only will they help by figuring out your taxes for you, but they also step in to assist during an audit—and that can mean the difference between a simple problem and a business-killing issue.
As always, none of the information in this post should be considered tax, legal or financial advice. Always talk to an expert!