How To Avoid A Tax Audit In 12 Simple Steps
Chances of receiving a tax audit are very low, but you can protect yourself even more by following our 12 steps on how to avoid a tax audit.
Want to avoid a tax audit? Keep your tax filings as accurate as possible.
Fortunately for small business owners, tax audits are both rare and mostly random. While some audits are launched as investigations against tax fraud, many audits are simply used to support the IRS’s statistical analysis projects. That said, most small business owners and individuals want to avoid tax audits.
If you find yourself worrying about tax audits, we’ve got you covered. This guide takes a deep dive into tax audits, including avoiding tax audits and what details may trigger a tax audit. Let’s dive in.
Table of Contents
- What Is An IRS Tax Audit?
- Is It Possible To Avoid An IRS Tax Audit?
- Common IRS Tax Audit Flags
- How To Avoid A Tax Audit
- 1. File Taxes On Time
- 2. Don’t Forget To Sign
- 3. Double-Check The Math On All Tax Forms
- 4. Record All Income
- 5. Don’t Overestimate Expenses
- 6. Don’t Round Numbers On Tax Forms
- 7. Be Careful With Deductions
- 8. Use Schedule Cs With Caution
- 9. Stay On Top Of 1099-NECs & W-9s
- 10. Consider Using Payroll Software
- 11. Hire An Accountant
- 12. Keep Solid Business Records
- The Bottom Line On How To Avoid A Tax Audit
- Tax Audit FAQs
What Is An IRS Tax Audit?
An IRS tax audit is the review of an individual or organization’s tax account and is performed to verify the accuracy of the tax information they’ve provided. If you are audited, the IRS will conduct a thorough investigation, including the examination of your tax returns, filing status, taxable income, and other relevant tax information.
If your business or personal tax account is audited, you will likely be asked to provide documentation that supports the information included in your tax return. That’s why it’s essential for businesses and individuals to save financial documents, such as receipts, bills, loan agreements, tickets, employment documents, and more.
Is It Possible To Avoid An IRS Tax Audit?
It isn’t possible to avoid a tax audit completely because the IRS may choose to conduct an audit through random selection. In other cases, someone else’s inaccurate tax filing may trigger an audit of your returns.
Although some reasons behind tax audits are unavoidable, you can greatly reduce your chance of being audited for discrepancies by being honest and accurate when filing your tax returns.
Common IRS Tax Audit Flags
Tax audits are typically caused by one or more tax audit flags or details that make your return stand out as potentially inaccurate.
While using accurate numbers and filing on time are easy ways to help avoid tax audits, knowing which factors will influence your likelihood of getting audited can also help.
Here’s a breakdown of common IRS audit flags:
- Underreported income
- Overestimated amounts
- Overuse of deductions
- Mathematical errors
- Earning $100,000 or more
- Operating a small business that deals primarily in cash
- Filing incomplete tax forms
- Overestimated donations
- Incorrect filing status
How To Avoid A Tax Audit
There isn’t a surefire way to guarantee the IRS won’t audit you. However, there are steps you can take to lessen your risk. Check out these 12 tips for avoiding an audit this tax season.
1. File Taxes 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. The Failure to File Penalty is 5% of the unpaid tax amount for each month (or portion of a month) that your return is late. It’s a heft penalty that can equal up to 25% of your unpaid taxes, so make sure to file on time every time.
Unsure of when taxes are due? Your annual return is due (along with your payment, if you owe taxes) by April 15. This date is pushed back to the next business day if it falls on a weekend or holiday.
Check out our small business tax guide to learn more about due dates and filing your taxes.
2. Don’t Forget To Sign
This is another minor thing that’s surprisingly easy to overlook. Forgetting to sign your name on your return may trigger an audit. You can easily avoid this error by using tax software, which walks you step-by-step through the process of preparing and filing your tax return.
3. Double-Check The Math On All Tax Forms
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 truly is the best policy. Don’t omit any income in your tax report, no matter how small the amount. Report all of the income you’ve earned during the tax year, including any assets you sold.
Make sure to be extra careful when editing transactions within your accounting software, as these can affect the income total reflected on your taxes.
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.
If you’re looking for an easy solution to simplify closing the books, there are numerous options available. Cloud-based accounting software like QuickBooks Online or FreshBooks are loaded with features and makes it easy to close your accounting periods. If you prefer locally-installed accounting software, QuickBooks Desktop Pro is an option to consider. 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 are truly business expenses, not personal expenses.
If you use a personal bank account for your business, be sure to separate your personal and business expenses carefully. This can be easily done using your accounting software. QuickBooks Self-Employed, for example, is accounting software for freelancers that allows you to easily track and separate your expenses.
6. Don’t Round Numbers On Tax Forms
This goes hand-in-hand with not overestimating expenses. Don’t round numbers on your tax forms, either up or down. If you spent $792.84 in office supplies 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 of 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: The IRS allows you to write off 50% of your meals and travel business expenses. However, if this deduction seems too excessive for your business type and income bracket, you may risk a tax 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.
The complete list of small business tax deductions will have more details about the deductions you may qualify for.
Looking for more tax credits for your business? Use one of these trusted ERC specialists to see if you qualify for the employee retention tax credit.
8. Use Schedule Cs With Caution
If you are a self-employed taxpayer, you are probably very familiar with Schedule C. Unfortunately, the IRS heavily scrutinizes Schedule Cs. That means you should take extra care when preparing yours. The IRS provides resources to ensure you fill out yours correctly, or you can hire an accountant or tax professional if you don’t want to tackle this task on your own.
If you want to avoid this potential red flag altogether, you could consider incorporating your business instead.
9. Stay On Top Of 1099-NECs & W-9s
Make sure you meet the 1099-NEC 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 to complete your 1099-NECs.
Once completed, you must send a copy of the 1099-NEC form to both your contractor and the IRS. You can use IRS resources to learn how to fill out and submit your forms properly, or you can leave the hard work to a tax pro or accountant.
10. Consider Using Payroll Software
Errors in your payroll can also trigger an IRS audit. Even one small discrepancy between tax withholding and payments can throw up a red flag to the IRS.
The best way to avoid this issue altogether is to use payroll software. In addition to helping you prevent costly errors, there are other benefits to using payroll software, including:
- Added security features
- Potentially less expensive than outsourcing payroll
- Gives you more time to focus on other aspects of your business
- Easy access to payroll records
- May include other features, including time tracking, employee management, and expense tracking
Take a look at our top payroll software recommendations to help get your payroll taxes in order. And learn more about payroll taxes in our complete small business payroll tax guide.
11. Hire An Accountant
My biggest suggestion to small business owners is this — hire an accountant or tax professional to file your taxes. Not only will this increase the chances that your tax return is correct, but you also stand a better chance of maximizing your tax deductions. When it comes to taxes, peace of mind is worth the cost.
12. Keep Solid Business Records
Our last bit of advice is to keep meticulous, well-organized records. There’s no guaranteed way to prevent a tax audit. If 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:
- 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 record bills, run reports, 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.
The Bottom Line On How To Avoid A Tax Audit
The bottom line is this: If you are organized and keep strong records, you should easily be able to 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 file your taxes successfully.
Want to learn more before filing your taxes? The ultimate small business tax checklist has step-by-step guidance on how to prepare and file your small business taxes quickly and accurately.
Also, if you claimed an Employee Retention Tax Credit, you might be worried about getting audited by the IRS. Here’s what you need to know about ERC tax audits.
As always, contact your accountant or a tax professional for specific tax advice. Happy filing!