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Everything You Need to Know About Avoiding IRS Tax Audits

No one wants to get audited by the IRS. It’s a long, drawn-out process that can be very expensive and damaging to your business. 

If your business is audited and the IRS finds errors in your financial statements, you may be subject to expense penalties and interest. In extreme cases, it can cost business owners tens of thousands of dollars and/or jail time. 

If you run a small business, your chances of being randomly audited are around 2.5%. Your chances increase if you fail to report certain earnings, claim business deductions that are disproportionate to your income, or perform other activities that peak the IRS’s interest. You can avoid unwanted attention from the IRS by following the steps laid out below. 

 

In this blog, you will learn: 

  • The top 9 red flags that could bring unwanted attention from the IRS 
  • Steps you can take to avoid an audit 
  • What to do if you happen to be audited 
Need professional assistance with your small business finances? Rooled is here to help.

What Can Trigger an IRS Audit?

The Internal Revenue Service (IRS) conducts audits of tax returns to ensure compliance with federal tax rules.  

According to irs.gov, “An IRS audit is a review/examination of an organization’s or individual’s accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct. 

 The IRS takes this action when they feel that there is something amiss with the information submitted on an individual’s or business’ tax return. 

9 Red Flags That Can Trigger an IRS Audit

There are certain things the IRS looks for when conducting an audit. If you’re doing any of these things in your business, it may increase your chances of being audited. Keep reading to learn more about the red flags you need to watch out for. 

1 – Not keeping good books and records

Bookkeeping may seem simple, but it is amazing how many business owners make mistakes with their records, which results in a lot more stress and hassle than there needs to be.

Make sure to keep accurate records of your income & expenses, as well as copies of all receipts for purchases made for your business. Make sure these items are recorded consistently each month.

2 – Claiming Too Many Business Expenses 

Just because an expense goes towards your business does not mean that it can automatically be deducted from your taxes. To avoid this mistake, take time to learn what types of expenses the IRS considers to be deductible before filing any paperwork or paying any fees. 

3 – Making mistakes on tax returns

A tax return that contains mistakes will trigger an audit. You must ensure you review your tax filings thoroughly before submitting them to the IRS.

Make sure there are no mathematical errors and that all required documentation is included. Information on a vendor’s W-Forms should also be reviewed carefully, as any discrepancies may increase the chances of receiving an audit from the IRS.

4 – Filing late or not filing at all

Regularly file your taxes on time and accurately. The most common mistake made by taxpayers is not filing their returns at all or submitting them late.  

Even if there is no balance due, you should make sure to send in your return before the deadline each year to avoid interest charges and other penalties. If you are worried about knowing which forms to fill out or getting them done on time, hiring a tax professional can save you from making mistakes. 

5 – Failing to report all income on your tax return

If you have multiple sources of income, this can be trigger that sends your tax return over for a closer look. As a business owner, it is important to know how much money you are making. Know that any time a discrepancy arises, it will be investigated further by the IRS.

6 – Excessive Charitable Donations

Another popular audit trigger has to do with charitable donations. Many business owners claim deductions from these contributions on their yearly taxes.

However, before you claim these deductions as business expenses, it is important to be aware of the narrow guidelines that govern these types of deductions, and what evidence is needed to back up your claims.

If you happen to fall into any grey areas on your tax return, prepare yourself for a little extra attention from the IRS.

home office deduction is available to startups

7 – Home Office Deductions

Finally, we come to another popular audit trigger that has to do with home office deductions. The number of those who take advantage of this deduction has increased significantly, which makes sense considering how many businesses moved to work-from-home models in 2020. 

Nevertheless, taking full advantage of this deduction requires meticulous record-keeping, filing of the correct forms, and knowing exactly what you are allowed to deduct from your taxes.  

8 – Multiple cash transactions

The IRS is especially interested in businesses that deal primarily in cash transactions. If your business receives cash payments on a regular basis, be sure to deposit them in your business bank account so there is a record of your earnings.  

Make sure you can provide a detailed explanation of all the income and expenses associated with it. Any cash payments over $10,000 must also be reported using IRS Form 8300. 

9 – Sole proprietorships reporting big losses year after year

While there is nothing wrong with having a sole proprietorship, it does come under increased scrutiny by the government for certain reasons.  

Because sole proprietorships are easy to set up and run, it is often used as a front by criminals for illegal activities. Additionally, sole proprietorships often report large losses year after year, which may signal tax evasion activity. 

How to Avoid an IRS Audit

Several factors can trigger an IRS audit, including filing your tax return late, failing to file your tax return, not paying your taxes on time, and negligence, which can involve varying degrees of ignoring federal laws and regulations. 

Even if you are never audited by the IRS, being well-prepared will help reduce any anxiety or stress that comes along with a potential audit. 

Keep Detailed Financial Records 

Document all your business transactions on time. Hang onto all your receipts and keep a record of all expenses and income related to your business. If you have a lot of complicated accounting work to do, hiring a financial professional is always an option. 

magnifying glass being used to read financial statements

Keep Additional Copies of Your Tax Returns 

In the unfortunate event that you are audited by the IRS, it’s always wise to have additional copies of your business’ tax returns. This will help make the process go smoother and reduce any potential headaches that may come along with an audit. 

Understand The Tax Regulations And Laws 

One of the easiest ways to avoid an audit is by understanding how you can legitimately reduce your business’ taxes. It’s also important for you to have a clear understanding of what expenses are claimed as deductions on your business tax return will help prevent an audit. Also, keeping up to date with any changes in tax regulations and laws will help you avoid getting into trouble with the IRS. 

How to Respond to an Audit

If you are notified that your business is being audited by the IRS, it’s important to remember to stay calm and be professional. An audit may be requested by mail or in person at your business. You should never ignore a request for an audit because even if you are not guilty of anything. 

Follow these tips to ensure your audit goes as smoothly as possible: 

1 – Contact your tax preparer or accountant so you don’t have to worry about any legal trouble that might come up due to faulty information. They can help you determine whether there was some sort of mistake made on your tax documents and fix it before the process goes too far. 

2 – Gather all your financial records related to the audit, including receipts and other documentation that supports the information on your tax return. 

3 – Be cooperative and honest with the IRS examiners. They are just doing their job and, by being cooperative, you can help make the process go a lot smoother. 

4 – Don’t panic. An audit is not the end of the world and, chances are, everything will be resolved in a timely and efficient manner. 

what if you are audited by the irs

How Long Does an IRS Audit Last?

That depends on the type of audit you are involved with – correspondence audits tend to be short and limited in scope; office audits can take longer particularly if the agent wants access to your business records which means that they must spend time out of the office to examine them. 

But in general, when someone is dealing with an audit, they are looking at an average of about 20 hours per week devoted solely to the matter – either preparing for it or trying to deal with its aftermath. 

The IRS is very thorough in its auditing process and if they find something that doesn’t seem quite right then there will likely be an audit. It pays to know what red flags you should watch out for so that you can plan accordingly. Let us help with tax planning or other financial services like bookkeeping or payroll processing. 

The IRS is very thorough in its auditing process and if they find something that doesn’t seem quite right then there will likely be an audit. It pays to know what red flags you should watch out for so that you can plan accordingly. Let us help with tax planning or other financial services like bookkeeping or payroll processing. 

Hire a Professional to Avoid Unwanted IRS Audits

An audit from the IRS doesn’t have to totally derail your business. By following the guidelines laid out in this blog, you are well on your way to paving a secure financial path for your business.

For more great information that can help your small business, check out these resources from Rooled:

Rooled is a leader in helping small businesses get a handle on their finances. If you need extra support getting your business financials in order, let us know. We offer CFO-for-hire, as well as outsourced accounting services to help you gain the financial footing your business needs to grow and thrive.

Need professional assistance with your small business finances? Rooled is here to help.

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