A tax audit or a letter from the IRS can be the beginning of a serious headache for many small business owners. You will be asked to check documents and receipts for a period of time in the recent past, and if this happens during a busy time for your business, it might get even more complicated. It’s not a bad idea to learn how you might be able to avoid an audit.
Luckily, only a small number of businesses actually get audited, and in most cases, the audit comes as a letter that requires further documentation.
Small business bookkeeping can be challenging and full of obstacles, but you can increase your chances of avoiding an IRS tax audit by understanding what accounting mistakes generally trigger suspicion and how to avoid them.
Don't Make These Seven Accounting Mistakes that are Likely to Trigger a Tax Audit in 2024
1. Make Sure Your Math Is Consistent and Correct on Your Tax Returns
Ensuring your numbers are accurate and truthful is the first step to avoiding discrepancies. If you’ve been issued a tax form by someone (like a 1099-MISC), the same form will be sent to the IRS, too. The IRS will check that the numbers match.
If there are discrepancies in the math, something so simple can become a trigger for a notice, letter of clarification, or audit. Alongside tax forms, ensure that your tax returns are also truthful and consistent.
Naturally, you might make mistakes, but you should always double-check your math and figures to ensure they match. It’s recommended to hire an accountant to ensure that mistakes on your important documents won’t be made.
2. Ensure Your Bookkeeping and Business Records Are in Order
When organizing your records, it is crucial to understand the importance of keeping business and personal finances separate. You should consider keeping your business income and expenses in a dedicated bank account while keeping your personal finances in another.
These two strategies, when combined, allow you to speed up the process of preparing and filing your tax return and ensure that you’re reporting separate and factual information on your personal and business tax returns. Additionally, you will have evidence to back your claims if you do get audited.
3. Avoid Overpaying Employees Who Own Shares in Your Business
In the case of a C corporation, it might be tempting to pay your executives higher salaries to minimize the corporation’s profits, thus lowering taxes. However, exceedingly high salaries for shareholders might end up triggering an audit. Instead, have a better understanding of the range of salary in your industry and stick to those general guidelines.
4. Don’t Consistently
Report Losses in Your
Business
Be cautious when reporting losses multiple years in a row. If you report a loss twice in a period of five years, the IRS may notice. The IRS might consider your business as a hobby and question your business expense deductions. They may wonder how you’re staying in business if you are not making a profit and assume that you’re taking deductions that could be considered personal in nature.
5. File Estimated Taxes
Every Quarter for Your Business
This is based on your net profits, not your gross revenue. If you believe that you will owe taxes by the end of the year, consider paying estimated taxes every quarter.
If your 1040 generates quarterly tax coupons for the following tax year, and your taxable income will be the same or more than the prior year’s tax return, deciding to pay these quarterly tax coupons can help you potentially avoid IRS penalties and interest.
6. Follow Guidelines Regarding Paying Independent Contractors
Some businesses might decide to hire independent contractors to avoid having to pay payroll taxes. The IRS and your state unemployment agency have defined guidelines for who is an employee and who is a contractor. Misclassifying a person can subject your business to a federal or state employment audit if you’re not following the guidelines regarding employee status.
7. Only Claim Legitimate Tax Deductions for Yourself and Your Business
When claiming business tax deductions, make sure they are legitimate and relevant to your business. Among the many items that might trigger an audit are ‘made-up’ business operating expenses, like using the prior year’s numbers. The IRS can easily compare year-over-year expenses to flag this in their systems.
Expenses that have been misreported or mis-documented for home offices and personal vehicle costs are some of the most flagged deductions.
Are your books IRS Audit-proof?
Ultimately, the best way to avoid a tax audit is to be completely honest and punctual with your taxes. While it’s impossible to promise that an audit won’t happen, double-check your numbers and submit truthful reports.
If you are in doubt, hiring a licensed CPA, like Insogna CPA is a great way to ensure that your taxes are reported accurately. Get your own CPA team to take care of your books and taxes.