12 Tips For Preventing A Business Tax Audit
As a small business owner during tax season, it can sometimes feel that you’re sitting on a ticking time bomb. Will you be audited this year? When? How? WHY?!
But, while the IRS does review some tax returns at random, most audits are in response to an error or discrepancy — and believe it or not, the percentage of tax returns that get audited is surprisingly small. Still, we don’t want you to be numbered among the few. Stop the audit clock by filing your taxes carefully and avoiding red flags.
In this post, we’ll cover 12 tips that should help you prevent a tax audit and file your taxes with confidence. We’ll also talk about which accounting reports you’ll want on hand if you do happen to get audited so you can survive the ordeal with ease.
Table of Contents
- 1. File On Time
- 2. Don’t Forget To Sign
- 3. Double-Check The Math
- 4. Record All Income
- 5. Don’t Overestimate Expenses
- 6. Don’t Round Numbers
- 7. Be Careful With Deductions
- 8. Use Schedule Cs With Caution
- 9. Stay On Top Of 1099-MISCs & W-9s
- 10. Consider Using Payroll Software
- 11. Hire An Accountant
- 12. Keep Solid Records
1. File On Time
A no-brainer, right? But if you fail to file your taxes on time, you automatically put an audit target on your back. Filing on time also ensures that you don’t have to pay the IRS late filing penalty.
2. Don’t Forget To Sign
This also seems like a no-brainer, but according to Investopedia‘s Glenn Curtis, a large number of people forget to actually sign their tax returns. In the article Avoid an Audit: 6 “Red Flags” You Should Know, Curtis says:
Failure to sign the return will almost guarantee that it will receive additional scrutiny. The IRS will wonder what else you might have forgotten to include in the return.
3. Double-Check The Math
When it comes to the totals on your tax forms, it’s imperative to double-check (or even triple-check) your math. The IRS often audits tax returns that contain math errors and discrepancies between forms.
Remember (and this is important): Even if you hire a professional accountant or tax expert, you’ll want to double-check their work. Ensure that all the numbers are correct and consistent before you send off your tax return.
4. Record All Income
When it comes to taxes, honesty really is the best policy. Don’t omit any income in your tax report, no matter how piddling the amount. Report all of the income you’ve earned during the tax year, including any assets you sold.
If your business grosses a large amount of money each year, you automatically incur a higher risk of audit. The BBB (Better Business Bureau) suggests:
If you fall under this category, be mindful of your increased audit potential and take extra time when preparing and reviewing your taxes. Stay organized and keep meticulous records, in case you are audited.
The BBB adds that small business owners need to be extra careful when editing transactions as these can affect the income total reflected on your taxes.
Small businesses should be wary of modifying invoices and payments within their accountings system from prior periods because the adjustments can potentially generate discrepancies in gross sales and the sales tax liabilities for that period.
A great way to avoid this problem is to close out your accounting periods and protect them with security codes. That way, only users with the code (preferably your admin and accountant) can make changes to old invoices and expenses. Software programs like Xero and QuickBooks Pro make closing your accounting periods easy. These programs also allow you to set user permissions to control each user’s access.
5. Don’t Overestimate Expenses
In the same way, don’t overestimate the amount you spent on expenses in an attempt to lower the amount of taxes you owe. Be precise and honest about all business expenses. Keep solid records of your receipts and be sure the expenses you claim truly are business expenses, not personal expenses.
If you use a personal bank account for your business, be sure to carefully separate your personal and business expenses. Some accounting software programs, like Wave allow you to easily separate these expenses.
6. Don’t Round Numbers
This goes hand-in-hand with not overestimating expenses. Don’t round numbers on your tax forms, either up or down. If you spent have $792.84 in office supplies expense for the year, put $792.84, not $793.00 (and definitely not $800).
Round numbers can be an indication of laziness, lack of precision, and even dishonesty — not exactly characteristics you want to display to the IRS.
7. Be Careful With Deductions
Tax deductions are great. However, certain often-abused tax deductions can draw the attention the IRS. Here are some of the most scrutinized deductions:
- Home Office Deduction: If you claim the home office deduction, be sure to deduct the exact amount you qualify for. If you claim too much, or your home office deduction changes year after year, you may risk a tax audit.
- Meals, Travel & Entertainment: The IRS allows you to write off 50% of your meals, travel, and entertainment business expenses. However, if this deduction seems too excessive for your business type and income bracket, you may risk a task audit.
- Charitable Donations: While charitable deductions are commendable, incredibly large charitable donations can raise red flags for the IRS.
Now, this doesn’t mean you shouldn’t take the deductions you are owed (and it especially doesn’t mean you shouldn’t make charitable donations).
Take all of the deductions you qualify for, but be completely honest and especially careful with these deductions. If you qualify for a deduction that is abnormal for your business size or type, be sure to have clear, precise records to show the IRS in case of a tax audit.
In his article The Top 10 Ways To Avoid An IRS or State Audit, attorney and CPA Mark J. Kohler suggests:
When necessary, include additional information with your return, to substantiate expenses and oddities that might catch the IRS’ attention. If your file gets handed off to an agent for further review, a real human can sometimes choose to bypass your return for an audit because you already provided the support the revenue agent was looking for.
Read What Can I Write Off As A Small Business Tax Deduction? for more details about the deductions you may qualify for.
8. Use Schedule Cs With Caution
If you are a self-employed taxpayer, you are probably very familiar with the Schedule C. Unfortunately, Schedule Cs are heavily scrutinized by the IRS. This means you should take extra care when preparing your Schedule C. Follow the IRS’s Schedule C instructions to the letter and seriously consider hiring an accountant or tax professional to ensure this form is prepared correctly.
If you want to avoid this potential red flag altogether, you could consider incorporating your business instead.
9. Stay On Top Of 1099-MISCs & W-9s
Make sure you meet the 1099-MISC filing deadline on January 31. You’ll need to request W-9s, the Request for Taxpayer Identification Number or Certificate, from each of your contractors in order to complete your 1099-MISCs.
Once completed, you must send a copy of the 1099-MISC form both to your contractor and the IRS. Follow the IRS’s 1099 instructions carefully to properly file all the necessary forms.
10. Consider Using Payroll Software
According to the BBB:
Discrepancies between payroll tax withholdings and payments are common triggers for correspondence audits, meaning one minor error can result in hefty penalties and interest.
The best way to avoid this issue altogether is to use payroll software. The IRS even suggest doing so, saying:
Many employers outsource some of their payroll and related tax duties to third-party payroll service providers. They can help assure filing deadlines and deposit requirements are met and greatly streamline business operations.
Contact your accounting software provider to see what payroll support plans or payroll integrations they offer.
11. Hire An Accountant
This is my biggest suggestion to small business owners — hire an accountant or tax professional to file your taxes. Not only will this increase the chances that your tax return is correct, you stand a better chance of maximizing your tax deductions. When it comes to taxes, the peace of mind is worth the cost.
12. Keep Solid Records
Our last bit of advice is to keep meticulous, well-organized records. There’s no guaranteed way to prevent a tax audit. In the case that you do get audited, the process will be much smoother and faster if all of your records are accessible and well-organized.
If you do get audited, here are the forms the IRS may request (according to the IRS’s audit guide):
- Canceled checks
- Tax preparation or advice papers
- Property acquisition papers
- Loan agreements
- Travel tickets
- Employment documents
Accounting software can be a huge help in this regard. Most programs allow you to run reports, record bills, and attach copies of receipts to expenses. Some programs also have an audit trail report which shows all of the activity on your company account.
Read our How Your Business Accounting Software Can Help You File 2018 Taxes post to learn which accounting reports you should run and how long to save your accounting records.
The bottom line is this: If you are organized and keep strong records, you should be able to easily defend yourself to the IRS in an audit situation. But hopefully, the 12 tips above will safeguard you from ever having to be in that scenario. We hope you found these tips helpful and will be able to use them to successfully file your 2018 taxes.
As always, contact your accountant or tax professional for specific tax advice. Happy filing!