If you’re a small-business owner, you’re about 2.5 times more likely to be the target of an IRS audit than the average taxpayer.

Diligently record all
transactions – no matter the payment method – and regularly reconcile your accounts.

The good news is that you can reduce those chances by steering clear of a few common tax audit triggers.

In this article, we’ll cover 10 red flags that the IRS looks for and how to avoid them when preparing and filing your taxes.

Before diving into the list, it’s important to emphasize that establishing a solid relationship with a seasoned accountant can go a long way toward solving many of the problems we’re about to highlight.

1 Missed Deadlines

The problem: Late income tax filings and payments can accrue penalties and interest and could suggest a worrisome level of disorganization in your financial recordkeeping.

The solution: Consult an accountant with a track record of supporting small-business owners who can help you schedule and manage your tax responsibilities.

2 Math Errors

The problem: Arithmetic and data entry mistakes account for many amended returns, and repeated or major blunders may cast doubt on your attention to detail.

The solution: If you are not using an accountant, consider using software that does all the calculations and cross-check your return against your records.

3 Round Numbers

The problem: It’s unlikely for a business to make precisely $200,000.00 in a given year, so it has been said that the IRS’s algorithm is trained to sniff out large round numbers as potential “guesstimates.”

The solution: Use real amounts validated by your financial statements, and don’t round other than to the nearest dollar.

4 Low Salaries

The problem: S corp status can help owners lower self-employment taxes by splitting earnings into salary and distributions, but disproportionately low salaries can attract scrutiny.

The solution: Pay yourself a reasonable salary that aligns with industry standards and keep the documentation.

5 Cash-Heavy Operations

The problem: Types of businesses that traditionally work with cash transactions (like bars, laundromats,
and barbershops) are perceived as being at a greater risk of underreporting their income.

The solution: Diligently record all transactions – no matter the payment method – and regularly reconcile
your accounts.

6 Excessive Expenses

The problem: Businesses can deduct “ordinary and necessary” expenses from their income taxes, but write-offs that seem outsized or irrelevant are liable to set off alarm bells.

The solution: Hang onto receipts and maintain separate personal and business accounts to avoid mixing funds.

7 Year-After-Year Losses

The problem: The IRS knows that startups take time to make a profit and all firms go through hard times, but continual losses make your business look like a misclassified hobby.

The solution: Document all your business expenses and consult an experienced accountant to ensure you’re not
over-deducting.

8 Claims of 100% Vehicle Use

The problem: Unless your vehicle is registered under a business name and used for business purposes, excessive mileage deductions will likely raise some eyebrows.

The solution: Keep a log with dates and addresses, and recall that commutes between home and work
aren’t deductible.

9 Incorrect Home Office Deductions

The problem: Independent contractors can deduct expenses associated with keeping a dedicated home office, but the IRS is looking for misapplications and exaggerations.

The solution: Remember that home office space must be for business use only, and review the two deduction methods.

10 Expensive Client Dinners

The problem: There was a time when executives could woo clients over lavish dinners and three-martini lunches, but thanks to tax code reforms, those days are long in the past.

The solution: Look up the current IRS regulations regarding business meals and entertainment, and keep your receipts.

Preparing for Success

While we’ve covered many of the generally accepted tax audit triggers, the exact process by which the IRS selects its targets remains a mystery (and random chance might play a role). The IRS may never audit your business, but it’s wise to prepare your taxes as though the possibility were a probability.

One of the best ways to prepare for an IRS audit is to conduct your internal audit with the help of an experienced small-business accountant. If your returns and records aren’t on the mark, you can take proactive steps to reduce your risk of a visit from the authorities – or at least make such a visit much less of a hassle.

You might also find it’s more than worth it to work with a professional for all your quarterly and annual filings. In addition to benefiting from economies of scale and expert advice, you can potentially offload some of the liability of preparing your returns. In the event of an IRS audit, an accountant can provide valuable support.

Work With a Trusted Partner

For individualized guidance on optimizing your tax strategies, consult your financial institution.

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