Audit Red Flags for Small Businesses

Freeimages/Paige Foster
Freeimages/Paige Foster

 

In many ways, owning a business can be rewarding: the chance to be your own boss, to conduct business in a way that is line with your own values, and to hire staff that you think will get the job done. The IRS  wants to make sure you are paying the taxes that you rightfully owe and aren’t committing fraud. Here are seven small business practices that can tip off the IRS and trigger an audit:

1. Regularly Claiming Business Losses

In some industries, this can’t be helped. Sometimes expenses far outweigh profits. Running at a loss also reduces your overall tax burden, and so the IRS is going to take an interest in businesses that report losses for two of the past five years. The IRS in this case has the option of re-classifying your business as a hobby, so you’ll want to keep meticulous records and provide documentation that can substantiate those losses.

2. Exceptionally High Salaries To Employee/Shareholders

If you are paying a higher than average salary to employees that are also shareholders in your company, the IRS will have one question foremost in their mind: Why are they being paid substantially more than others on your payroll?

3. Claiming Personal Expenses As Business Expenses

The IRS looks very closely at expenses such as medical, meals/entertainment, cell phone and travel when dealing with a small business. Unfortunately, there have been shady business owners who have had a field day with claiming personal expenses as business expenses.

Your business could attract closer IRS scrutiny if expenses in the above categories tend to be outside the norm for comparable businesses in the same industry. The burden of proof will be on you or your tax pro to demonstrate those costs were normal and customary in the course of running the business.

Keep detailed records of your business-related expenses and keep all receipts associated with them. In the event you are selected for an audit, you will be able to substantiate your claims.

4. Claiming Personal Vehicle Use/Expenses as Business-Related Vehicle Expenses

It may be tempting, but don’t do it. Nothing sends up an “audit me!” red flag to the IRS like vehicle expenses.

If your car is registered in your name but you are using it to conduct business, the IRS will look at this more closely than if the vehicle were registered in the name of your  business.  While not every business owner can finance a car under the business’s name, every business owner can and should keep detailed records of vehicle use for business.

Keep track of business-related mileage, fuel costs, insurance, registration and other related expenses. Only claim what is allowable under law. Keep all supporting documentation in case your business returns are audited. You will need these to support your claim of business vehicle expense.

5. Cash Business

Businesses such as hair salons, restaurants, home day care, and car washes have a higher proportion of cash transactions than other businesses. Be sure to issue a customer receipt for every transaction to document cash flow in and out of the business. Keep detailed payroll and expense records, and hold on to all supporting documentation in the event of an audit.

The IRS looks very closely at cash-based businesses, even if there is no wrongdoing on your part. Detailed records and copies of issued receipts will go a long way toward reassuring the IRS you are not committing fraud or laundering money.

6. Making Late Payments or Filing Late Returns

If you are consistently late in filing your business return or paying taxes, you could increase your risk of an IRS audit.

Make every effort to file your business returns and to pay your related taxes on time. The IRS may suspect you or your business of fraud or other tactics in light of late payments or returns, so timely payments and returns will be to your benefit.

7. Shifting Income to Avoid Taxes

There is no doubt that small business owners are faced with a higher tax liability than an individual who works for an organization. It may be tempting to lower your overall business tax liability by shifting income to non-taxable entities, such as a charity. Don’t do it.

If the IRS even suspects you are shifting income to avoid taxes, they will come calling. Instead, pay what you rightfully owe. If you find yourself in over your head and can’t make the payments on time, find a qualified tax pro who can help you sort out your options.

Small business ownership can be as rewarding as it is demanding. Unfortunately, small businesses fall under suspicion with the IRS because of business owners resorting to unethical tactics to avoid paying taxes or to lessen their tax burden.

Keep accurate and detailed records. If record-keeping isn’t your strong suit, hire a bookkeeper or an admin. assistant to take care of that task for you. Whatever you do, don’t falsify records or shift income.

You may find yourself at the receiving end of an audit notice even with the best of business practices. Try not to panic and enlist a qualified tax pro ASAP who will  walk you through the audit process and represent you before the IRS.

Don’t let the possibility of an audit deter you from owning a business. With sounds business practices, honest record-keeping and a good tax pro by your side, you can withstand an IRS audit.

 

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