It is the stuff of nightmares. An official looking envelope arrives in your mailbox announcing that your small business is going to be audited. Then an austere-looking man wearing a dark suit and holding a briefcase shows up at your office asking to see all your receipts, wanting to look around and asking all kinds of questions.
The good news is the IRS audits only a small percentage of small businesses, so the odds are on your side. However, there are some precautions you can take to keep your business from being one of the unlucky few.
Check and Re-check Your Numbers
We all make mistakes, but if your numbers don’t add up on your return, you will be raising a red flag. Double and even triple check your figures and your math.
You also invite questioning if the numbers on your tax returns do not match the numbers you have given to any third parties on other forms such as 1099 forms.
File a Complete Return
Amended returns may gain more scrutiny. File for an extension rather than sending in an incomplete return.
Don’t report Too Many Losses
The IRS can get picky about reports of net losses year after year. In fact, if you report a net loss more than twice in five years, you may trigger an audit. The IRS may see your business as a hobby and disallow your deductions for business expenses.
Keep Detailed, Organized Records
Maintain separate business and personal accounts. Retain all business receipts and organize them so that they are easy to locate.
Be Accurate and Specific
Don’t overstate expenses or attempt to hide any income. Avoid rounding numbers to the nearest ten or hundred. Round numbers can give the impression that they are fabricated.
Pay Reasonable Salaries
If your business is a C corporation, you may feel that paying your executives a higher salary is a good way to minimize corporate profits and pay lower taxes. However, this practice can get you some unwanted attention from the IRS.
You can fly under the radar by keeping to a reasonable salary range for your industry.
Follow the Rules for Independent Contractors
Using independent contractors can be a great way to “staff” your small business. However, some small businesses use independent contractors as a way to avoid paying payroll taxes.
Adhere to IRS guidelines on who must be classified as an employee and who is an independent contractor. For more information, visit http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed.
Take Legitimate Deductions
For example, if you use part of your home for business, you may be able to take a home office deduction. A home office deduction could raise a question with the IRS, however, if you have large expenses for utilities or if you claim a deduction for home office and also have an office elsewhere. For more information, visit http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Home-Office-Deduction
Look for Ways to Document and Substantiate Your Deductions
Be creative in substantiating your deductions. When documentation is tricky, the IRS does allows for oral testimony, third-party documentation and other forms of documentation, including maps, client records and invoices.
Also, if you have reported certain expenses but no longer have receipts or documentation to document these items, take time to retrieve prior bank records or credit card statements. It is also beneficial to make contact with vendors to request proof of payment
Lastly, one of the best ways to avoid an audit of your small business is to use a professional to prepare your tax return. Tax professionals will help you take the proper precautions to avoid an audit. They also will represent you of you are audited.
If the IRS does select your business for a tax audit by the IRS, you will receive notification by mail or by telephone. You will receive a written request for specific documents.
There is no way to completely audit-proof your business. However, if you follow the above precautions, you are less likely to be selected. And, you will be more prepared to have a successful outcome if you are audited.