Here’s How to Avoid An IRS Audit
Just about every business owner fears an IRS (Internal Revenue Services) audit, and there are good reasons for that. Becoming subject to a full-fledged audit will force a business owner to turn over many documents and answer dozens of probing questions.
Even the disruption to business that results can negatively impact an entire company. When IRS auditors start digging into the details, they also frequently discover problems that can subject a business owner to fines and even worse.
Timely, accurate tax filing and payment will always help make an IRS audit less likely. Being aware of the kinds of issues that most often trigger an IRS audit will help to avoid problems.
7 Red Flags to Avoid an IRS Audit
1. Under-Reported Income
Entrepreneurs who own pass-through entities like sole proprietorships and limited liability companies typically include business income on personal tax returns. Sometimes that income is under-reported. It’s understandable to make honest mistakes but it’s important to report all income sources.
Private-sector auditors who hold the SOC 1 Certification are adept at rooting out under-reported income problems within corporations. IRS audit accountants are every bit as competent and frequently discover under-reported business income during preliminary analysis.
The best way to avoid triggering this common IRS audit trap, of course, is to report every bit of business and personal income. Even taxpayers who fail to report certain types of income for years often end up being caught.
2. Unusually Large Expenses or Deductions
The IRS classifies businesses according to the industry they operate in. The agency uses this information in a variety of ways, some of which are directly relevant to taxpayers.
Should your business expenses or personal deductions seem excessively large compared to the average in your industry, for instance, you might become subject to an IRS audit. In many cases, the IRS will first send a letter asking for clarification before taking this more-involved step.
3. Claiming Certain Deductions and Expenses
While the sum total of a taxpayer’s deductions, tax credits, and expenses can trigger an IRS audit, so might simply claiming certain types of them. For example, the Earned Income Credit has become notorious for its ability to trigger audits. This is not to say that potentially problematic tax-reduction tools should be avoided, but they should never be abused.
4. Writing Off Losses
Business owners are typically entitled to write off their losses to reduce taxable income. Some business owners try to get too clever in this respect, though and end up being audited. Should it seem tempting to write off the money you spent on a hobby as a business-related loss, for instance, some self-control will be in order.
5. Digital Currency Usage
Fans of digital currencies like Bitcoin often appreciate how they enable transactions that are difficult to trace. Report too much-related activity on your tax returns, though, and the IRS will likely want to take a closer look.
6. Mathematical Mistakes
Software-based tax preparation systems promise to rule out math errors. If you make too many mistakes when preparing your own returns, the IRS’s audit scheduling processes will likely catch them. This is especially true of repeated mistakes that all work out in your favor, which are signs that something more than merely being bad at math might be to blame.
7. Unreported Foreign Accounts
It has become so easy to move money and other assets around that tax-avoidance tools once reserved for the wealthy are now available to everyone. The IRS requires most taxpayers to report their foreign account holdings so it can be sure of getting its slice of the pie. If you try to hide assets overseas and get caught by the IRS, an IRS audit probably awaits you.
In conclusion, it’s important to check yourself to be sure you’re not setting off any of these 7 red flags. If you do, it can make an IRS audit more likely. In most cases, business owners who simply strive to stay honest and transparent should be able to avoid any IRS Audit problems.