Our tax pros’ best advice for preventing IRS stress, fines, and more.
Ask any small business owner and they’ll tell you: receiving a notice for an IRS tax audit is a top concern.
Nobody wants to become the target of an audit, which can not only end in fines or criminal charges, but more commonly ensures lost productivity and extra stress.
Here’s how to avoid becoming a target, plus what to do if you receive an audit notice.
While the IRS works to prevent tax fraud and illegal business operations, each year many small businesses find themselves facing a lengthy and stressful IRS tax audit.
Even business owners who have done nothing wrong and filed honestly will lose time and sleep answering questions, preparing documents, and hoping they’ve done everything correctly.
A tax audit is often launched after IRS tools compare your business to similar businesses and past tax years, analyzing your documents for abnormalities or suspicious activity; if something stands out, an audit may be launched. Or, if someone connected to your business, like a partner or investor, is facing an audit, you may, too.
But what every small business owner should know is this: being selected for a tax audit is not exactly random and, while you cannot prevent every audit from happening, you can reduce your risk.
Below, discover 4 proven ways you can reduce your risk of a tax audit, plus what to do if you find yourself with an IRS audit notice.
First, let’s determine what a tax audit is, according to the IRS:
“...a review/examination of an organization's or individual's books, accounts and financial records to ensure information reported on their tax return is reported correctly according to the tax laws and to verify the reported amount of tax is correct.”
Typically, there are two ways audits occur. They’re conducted by mail and you send documents to the IRS. Alternatively, you may be selected for an in-person audit, which means visiting an IRS office or an agent may come to your home or business. You can also choose an in-person audit if you have too many materials to be sent via mail.
You’ll need to provide extensive documentation about your business expenses, income, and other financial details, from canceled checks to loan agreements to receipts. It’s important to remember: keep all of the documents you use when you file taxes, in case of an audit.With more IRS funding and a greater focus on ensuring tax compliance, some experts estimate tax audits have increased by 50% between 2010 and 2017 with no signs of slowing.
Yes, every single sale, including cash payments and transactions through Venmo, PayPal, or other platforms. Because the IRS receives tax records and documents from others, they’ll likely know if you’ve excluded a $50 Venmo transfer or didn’t claim the $500 you earned by selling old equipment on Craigslist.
We always recommend keeping detailed, digital records of your sales so, if you do face an audit, it’s easy to recall where money came from and when. The IRS auditors don’t want to hear you struggle to explain where $10k came from—even if it’s a simple matter of forgetting!
While tax deductions are a legal and strategic way to optimize your taxes and lower your tax burden, claiming too many deductions—or out of the norm deductions—is a red flag for the IRS.
For example, your cell phone bill and work vehicle are likely safe, logical deductions. However, claiming your family’s cell phone plan on your business taxes, plus a speedboat for “advertising purposes”, will raise the suspicions and eyebrows of IRS auditors.
Some deductions may not be entirely appropriate or logical for your business, like claiming $50,000 in hotel expenses for a local landscaping outfit. If it’s hard to explain or justify, the IRS is likely to jump on this.If you’re unsure of what’s appropriate to deduct, a tax professional can help you not only strategize which deductions to claim, but also help you find new deduction opportunities.
Businesses change year to year; you may have one-time expenses, fantastic years, slow years, and unavoidable inconsistencies over the lifetime of your business.
However, you should strive for consistency in your taxes. For example, major fluctuations in income or expenses raise suspicion, which includes large changes in dollar amounts, surprising deductions, or significant income variations.
You may be asking: how can I get a grasp on consistency when so much is outside of my control?The truth is: a proper tax strategy is designed to bring consistency to your taxes, so consulting a professional to help you determine when to claim deductions, how to prioritize purchases, or other strategic decisions will not only likely lower your tax burden, but should make you less of an audit target.
A major red flag for the IRS is a late tax filing or unpaid tax amount. However, as a business owner, you may find yourself so underwater, distracted, or busy that you simply cannot devote the time and attention to preparing or filing your taxes.
While missing the deadline may occur on occasion, it’s vital to let the IRS know your taxes are coming; always file an extension request to avoid creating undue attention on your business.
If you haven’t picked up on it already: taxes are complex and the risks are substantial when done incorrectly. It’s easy to become the target of an IRS tax audit through simple mistakes or errors.
That’s why most small business owners choose to work with a dedicated tax professional, even if they have experience themselves or an in-house accountant or bookkeeper. Having someone to plan and strategize your taxes is key, as is ensuring your taxes are filed properly and legally; it reduces your risk of audits and litigation.
One thing to be aware of: just like a tax audit can be sparked by a common biz connection, tax preparers can also be an audit trigger. Tax professionals who operate in a Better Call Saul way often become IRS targets and, therefore, so do their clients.
Choose your tax professional wisely and look for pros with considerable experience and credibility.
Fortunately, IRS tax audits are common and, typically, do not end in fines or criminal charges, though they are stressful and time consuming. If you are facing an IRS audit, it’s not the end of the world—but it is important to respond to the IRS correctly.
For this reason, LedgerWay offers Audit Support Services, giving you the expertise and knowledge you need to get through the audit, plus the help you need to focus on your business instead of paperwork.
Have questions about your taxes, or want to learn how a tax strategy can help prevent audits? Book a call with our team now.
National Business Development & Sales Manager
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