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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

Simple Ways to Avoid IRS Audit of Your Small Business

Simple Ways to Avoid IRS Audit of Your Small Business

A small business needs to get its tax right to avoid unnecessary headache with the IRS. The idea is simple – a plain and accurate disclosure of losses, revenues and deductions you claimed will make things go smoothly. Should you get it wrong with any of these, expect severe consequences from Uncle Sam like liens, foreclosure and in some cases – audits.

Even though Uncle Sam plans to increase the number of business audits in 2021, there are practical tips with which you can stay off the radar.


Understanding IRS business tax audit 

Filing taxes involves the provision of a detailed cash flow of your business to Uncle Sam. This will typically include your entire income, entire costs alongside any credit or deduction you want to claim for the past tax year. If for any reason, Uncle Sam believes there is an error on your business returns or you are hiding something, Uncle Sam will mobilize its staff to make sure everything is gotten right. 

Typically, there are three years after the submission of a tax return to have an audit. Usually, an audit will happen by mail, at Uncle Sam's office or your office. It will involve an IRS agent going over your records to detect any issue with your return.

After the completion of the IRS audit, there will be a verdict, which you can either take care of or file an appeal with the IRS Office of Appeals within a month.


How to avoid a tax audit for Your Small Business 

It is possible to reduce the probability of getting audited by taking some steps with your return and avoiding something. Here are proven steps that can significantly lower your odds of being audited

  1. Be Thorough Neat and Accurate 

Series of math errors will raise eyebrows. However, you can make your return look more professional by using tax software to limit the possibility of mistakes. To be accurate, your records need to be concise and detailed such that you can prove anything on your return. With a sloppy return, proving might not be so easy. 

  1. Avoid Rounding up Numbers

While you think estimating your income and losses with rounded figures will make things easy for you, the presence of inconsistency in your tax will be evident to the IRS agent, which an auditor will likely capitalize on. 

  1. Have Good Explanation

Stay away from vague business expenses and categories that many businesses use, like miscellaneous expenses. If you are claiming unusual deductions, something that many businesses does not usually claim, be ready to provide detailed documentation or explanation

  1. Consider Electronic Filing

There are times you have to file electronically as it is convenient. With electronic filing, Uncle Sam can access your entire return, and it also has a way to check your data for errors. The built-in tools help ensure you have accurate data.

Also, tax software gives an audit protection guarantee where you will be protected if there is an audit. 

  1. Be Careful of Home Office Deductions 

Uncle Sam loves targeting tax deductions that take the home office deductions. As a result, be sure to know the rules if you want to take the home office deductions on your return. 

Your home office needs to be completely separate or an area designated for your business exclusively. 

  1. File Early

You have no reason to miss the tax deadline as one can easily file for an extension. However, do not forget that all the tax money you owe is due by the original filing deadline. Uncle Sam only gives you an extension for the paperwork. 

  1. Take Note of the Income-to-deduction Ratio you take

You have a massive chance of being audited if the difference between your expenses and income is more than 52%. Any huge deductions will raise eyebrows, notwithstanding if you have other small deductions that are in line with the rules. 

  1. Be Careful of the Independent Contractor 

Businesses that frequently use freelancers and various forms of independent contractors must be sure that they meet the status of independent contractor. If not, Uncle Sam might conclude they are workers, slam you with a massive bill for penalties and back payroll taxes.



Jim McClaflin, EA, NTPI Fellow, CTRC
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