Tax season makes a lot of people nervous.  They are worried that they might owe money or that they haven’t done their taxes properly.  They worry about whether or not they will get a notice that says they are being audited.  The truth is that most people can relax.  Even if you did make a mistake, most aren’t severe enough to trigger an audit. Before you submit your returns for your company, you should understand what these red flags are and how they can lead to your small business being audited. 

Red Flags That Can Trigger a Tax Audit For Small Businesses

1. Repeatedly Reporting Losses

Every business experiences a loss at some point. However, when you report losses year after year, you invite the attention of the IRS to your returns. In fact, reporting losses for more than two years out of the last five could cause the IRS to re-label your business as a hobby rather than a valid entrepreneurial enterprise.

If you legitimately experience chronic losses, you should provide plenty of documentation to back up your claim and also provide some sort of proof that you are running a valid company. It would work in your interest to show that you have an active marketing plan in place and are using other business tools like advertising to prove that your business is more than a hobby for you.

2. High Income

The biggest red flag that may trigger an audit is having a high income.  The reason is simple: the IRS is not going to waste their resources pursuing someone who is cheating them out of a few hundred dollars.  It would cost far more to investigate than they would get back.  However, those who pay hundreds of thousands in taxes every year, they are the ones that make the IRS more money.  Here is a rough breakdown of your chances of being audited:

If you make up to $200,000, your chances of an audit are about .9%.  $200,000 to $1 million those chances jump to 3.25%.  If you make over $ 1 million they surge to 11.1%.  Keep in mind that sudden increases in income can also trigger those audits.  It might look a little odd to the IRS if you make $100,000 one year and the next year you are only reporting $25,000 in taxable income.

3. Not Using Fair Market Value

This one is a bit trickier, and harder to catch (unless those who are doing their reporting are blatantly careless).  Let’s suppose you need to buy a new piece of equipment for your truck.  When brand new the equipment might be $10,000 and used it could be $5,000.  You might be tempted to buy the used piece, and write off on your taxes the amount for a new piece.  Can you get away with it?  Yes, you can.  But it could trigger a red flag and cause the IRS to come knocking.  Now you could always up your odds of being caught by claiming you paid $20,000; but most wouldn’t even dream of taking that chance. Be sure to keep all receipts for major items to back up your deductions.

4. Claiming Personal Expenses as Business Expenses

Some business owners think to recoup personal expenses by listing them as related to business on their returns. When you report high cell phone bills, meal expenses, travel costs, and other deductions, you elevate the risk that you will be audited.

The IRS will want to know that those expenses legitimately belong to your small business and are not yours alone to bear. You must prove that you incurred these costs during the course of running your own business and provide receipts to back up your claims.

5. Running a Cash-Based Business

Many types of businesses are based primarily on cash transactions. Hairstylists, waiters, car washes and others often take in more cash than they do credit card receipts.

However, these kinds of businesses are also more likely to be audited simply because cash transactions raise the risk of fraud. The IRS may argue that you could hide some of your income or be unable to prove that the money you reported is actually the amount you took in last year. You can dispel some of this doubt by keeping immaculate records and by giving your customers receipts for each and every transaction that comes into your business.

6. Consistent late filing of tax returns and payment of taxes.

Failing to follow filing requirements and meet deadlines triggers penalties, interest and unwanted attention. Always ask for an extension if you won’t be able to meet a deadline.

7. Claiming Vehicle Usage as Entirely Business Related

As with personal expenses as business-related, you also give the IRS pause when you list a company vehicle as being used entirely for business. Even if it is truly used for business use only, you may have a difficult time proving this.

The easier solution may be to avoid making this claim on your small business return. If you insist on claiming a vehicle as one used solely for your company, you should provide gas receipts and other documentation to back up this information.

Small business owners like you are often put through the same examination as private taxpayers when you submit your company’s returns. You can avoid an audit and get your returns to be submitted successfully by knowing the common red flags that may otherwise convince the IRS to audit your small business.

8. Typos and Entry Errors

Let’s face it, mistakes happen.  No matter how careful you are, your tax return may end up with a typo, or worse you could put the decimal point in the wrong place and cause your numbers to be off by thousands.  Make sure you double-check your tax return carefully so that you aren’t audited because you misspelled a word or two.

What To Do if your Small Business Gets Audited

The audit notice will include your auditor’s contact information, instructions on your next steps, and a list of documentation or information the auditor wishes to examine. You should follow these instructions closely, and carefully compile and organize the information that the IRS has requested. Showing up to the audit with the legendary shoebox full of receipts will not be to your advantage.

During an audit, the auditor will compare the tax return for the year under examination to the business’s books for that same year. You’ll need to share your financial statements, such as your profit and loss statement, balance sheet, and other documents that you used to prepare your books. They might also ask for other source documentation, such as invoices, receipts, and bank statements. The auditor’s job is to ensure that there are no errors on the tax return for the audited year.

Hire a Remote Accountant for Your Small Business

Hiring a remote tax accountant is the surest way to help you avoid an audit. An accountant’s guidance and expertise during year-round operations will add extra benefits, including efficiency and precision in your company. Think of an accountant as a long-term partner who is invested in your business and cares to keep it fiscally sound.

Limitless Investment and Capital Tax Accountants

Our proactive business tax planning strategies leverage every deduction, break, and incentive available to save you money on taxes. Schedule a FREE CONSULTATION today!