Business audits can interfere with outside investments, mergers, or acquisitions and drag on for months, causing delays to business plans. Considering how hard surviving an audit can be, the desire to avoid an IRS audit is understandable.
Every year, the IRS will randomly select a number of returns for scrutiny, making it harder to eliminate the likelihood of an audit. Although most audits result from problems with filed tax returns, certain triggers increase the odds. In fact, the IRS pays attention to a number of warning signs. To help keep your organization from audits, here are the six most common issues that might lead to a business audit.
Consistently late filing of tax returns
Aside from triggering penalties and interest, failure to meet filing deadlines brings unwanted attention. In fact, regular late filing more than doubles the risk of an audit. Planning ahead and getting started on your tax returns before the year’s end is one way to avoid this issue. You can also avoid late tax returns by asking for an extension, which does not increase the risk of an audit.
You must, however, file a tax estimate when requesting an extension, and unless you complete and mail your tax estimate to the IRS before the deadline, the extension won’t be valid. If you don’t have the funds to pay in full, you are required to file a written installment agreement request along with your return. Otherwise, the IRS might perform an audit.
Errors
Tax return errors are another red flag, the most common being mathematical errors or incorrect calculation of taxes. Other common tax return errors include:
- Filing the wrong forms
- Filing status errors
- Unsigned forms
- Incorrect business information such as names and bank account numbers
- Mailing tax returns to the wrong IRS processing center
Working with a certified tax professional is one way to avoid most of these errors and using a computer program to prepare your tax returns is the other. Both ways can help ensure accuracy. Remember to use the mailing envelopes and labels provided by the IRS.
- Reporting a net loss for three consecutive years
Reporting a net loss for three out of five years increases the likelihood of a business audit. As such, you could get audited because you’ve been struggling to maintain a profit. While this issue relates more to your business operations and less to your tax reporting, the situation is not easy to avoid. You should prepare for a business audit in advance if it seems likely to be your third consecutive year reporting a net loss. Make sure you follow the guidelines for reporting business expenses. Remember, all of your documentation will be reviewed. Also, inaccurate reporting of expenses could trigger penalties.
Reporting inaccurate business expenses
Excessive deductions are another potential red flag. You might get audited if the IRS suspects you’ve filed falsified business expenses. You’ll need supporting documentation for any business expenses you want to deduct from your taxes. Refrain from overstating your claims and keep every receipt related to all of these expenses. In the event of an audit, your receipts and records will be reviewed.
Unnecessary deductions can also trigger a business audit. For instance, claiming that you used the only vehicle you have for nothing other than business. The same applies to other major equipment. Also, the IRS might hold the return for review if the amount in the miscellaneous expense category is deemed excessively high. Remember, improper payment protocols can trigger audits.
Operating a cash-intensive business
Cash-based businesses are a potential trigger for increased scrutiny. Beauty salons, barber shops, and restaurants are some of the businesses likely to get audited as a result of underreported taxable incomes. The nature of their businesses makes their recordkeeping requirements extremely complicated. If you’re running a cash-heavy business, keep your yearly receipts and POS reports well-organized. Proper preparation is important because it can help ensure an IRS audit goes quickly and smoothly.
Paying unreasonably high salaries
If the IRS detects you are paying large salaries to shareholders, particularly those who are also employees, you could get audited. If you have employees who are also shareholders, determine a reasonable salary based on the type of business you operate and the employee’s skill set. Aside from those that are too high, the IRS also looks for salaries that are too low. Since the shareholders of some corporations can take profit distributions without running the risk of double-taxation, the IRS knows that receiving low salaries and high distributions allows shareholders to avoid payroll taxes.
