If you’re like most small business owners, you want an IRS audit about as much as you want a hole in the head.
Even though tax audits are relatively rare, with less than 1% of tax returns being reviewed by the Internal Revenue Service, small businesses do face a slightly higher risk. The reason for the uptick is that small business owners and self-employed individuals sometimes trigger an audit inadvertently due to an honest mistake, disorganized records, or a gentle fudge of the numbers.
The tax professionals at Levy & Associates Tax Consultants have prepared five tips to help you avoid and survive an audit.
5 Audit Tips for Small Businesses
Follow the tips below, and you can significantly reduce the probability of an audit.
1. Make sure the numbers add up.
Of course, this might seem obvious, but it’s important to be diligent in your addition and make sure everything balances. For example, if you do any work as an independent contractor, your client will submit copies of your 1099 to the IRS. If you fail to report that income or the earnings don’t match, the IRS knows where to start their search.
Similarly, if you hire independent contractors, make sure you issue 1099s to ensure that you’re there is a record of this claimed expense.
2. Be diligent about your receipts.
Again, this might seem like common sense, but paper receipts can fade over time, and the last thing you need is to hand over a stack of blank papers as proof of your expenses because the ink disappeared. Consider using a smartphone app to snap photos of your receipts and cloud-based accounting software to ensure you have detailed records of your financials for the year.
3. Avoid reporting consistent losses.
Businesses have the singular goal of making money, and if you show consecutive losses, the IRS will begin scratching its head. After all, if your business isn’t making a dime, why does the company exist? The IRS will conclude that you’ve either manipulated the numbers or the business is a hobby. Either way, you’re at high risk of an audit.
4. Be reasonable with your deductions.
Small business owners have a lot of leeway with deductions, and you may be tempted to write everything off to minimize your tax bill. There’s nothing wrong with deducting legitimate business-related expenses, but it’s also important to follow the current tax code.
The IRS has millions of tax returns and a baseline for everything. If you’re claiming a six-figure deduction for office supplies when other businesses of the same size in your niche and location claim significantly less, the IRS will be suspicious.
Businesses that maintain a home office or work solely out of their homes are also vulnerable to increased scrutiny. Again, there’s nothing wrong with these deductions, but don’t exaggerate. For example, a spare bedroom used solely as an office may be deducted, but the square footage of your dining room table cannot.
5. Don’t abuse independent contractors.
Hiring independent contractors is a great way to save money on labor. Because they’re not employees, you don’t have to provide benefits, and their work tends to be piecemeal or on a contract basis, so you can often avoid having to pay either idle time or overtime.
The IRS, however, may scrutinize a labor force that has a disproportionate number of independent contractors because it’s missing out on receiving state payroll taxes. As long as you are not misclassifying independent contractors as employees, you should be in the clear, but be prepared to argue your case.
Need Help with an Audit? Contact Levy & Associates Tax Consultants
Whether you’re proactively working to ensure your tax returns are above board or you’re reading this article because you’re being audited, the tax professionals at Levy & Associates Tax Consultants can help. Contact us at (800) TAX-LEVY for a free consultation.