Watch Out for These 7 Small Business Tax Audit Triggers

Tax season is right around the corner and if you’re a small business owner, you can’t afford to delay in preparing your return. It’s time to begin organizing receipts, tracking down invoices and tallying up your expenses as we head into 2015. One of the things that small business owners should be most concerned with is making sure their filing doesn’t raise eyebrows with the IRS. While there’s no way to ensure that your return won’t be subject to closer scrutiny, you should keep in mind that making any of the following errors could increase the likelihood of a small business tax audit.

  1. Underreporting income

As a small business owner, your chief responsibility is to maintain accurate records, especially when it concerns the amount of money that’s coming in. Failing to properly report all of the income you’ve earned will send up a big red flag if your records don’t match up with what the IRS has on file. This is especially important if you operate a cash-only business, since discrepancies tend to be examined more closely by the tax agency.

  1. Improperly classifying workers

If you have one or more people working for your small business, you need to use caution with how you classify them for tax purposes. Identifying workers as independent contractors can save you money, since it allows you to avoid paying employment taxes or insurance benefits but it becomes problematic if the IRS determines that they meet the standard to qualify as an employee. If your return shows multiple 1099s issued to workers, be aware that it could lead to a more in-depth inspection of your return.

  1. Combining business and personal expenses

Small business owners can minimize their tax liability by claiming deductions for expenses related to the cost of operating. What they cannot do, however, is include personal expenses in their calculations. The IRS has clearly defined rules about what qualifies as a business expense so you’re only putting yourself at risk if you attempt to include something that doesn’t meet the tax code standards.

  1. Claiming excessive deductions

While the IRS does not reveal the specifics of how it determines when a small business’s return should be audited, there are some unspoken rules to keep in mind. One of them involves how your deductions compare to your industry as a whole. If what you’re attempting to write off exceeds what’s considered the norm for businesses that are similar to yours in size and function, it’s possible that you may be asked to explain why.

  1. Significant changes in income

The IRS also pays close attention to how much money your business is bringing in and a dramatic spike in income won’t go unnoticed. If your business has finally taken off after being fairly static for a number of years, that’s excellent in terms of the size of your paycheck but it can be bad news from a tax perspective. Keeping detailed records showing how your income has increased or decreased over time is your best protection if you’re ever targeted for an audit.

  1. Consistently losing money

Building a successful business takes time and in some cases, it may be years before you begin to see a profit. If you’re filing a business tax return each year, the IRS is going to want to see that you’re making money at some point. When you’re reporting only losses for three years out of five, it could call into question whether you’re operating a genuine business or if you are participating in a hobby. This directly impacts your ability to deduct certain expenses.

  1. Mathematical errors

It may seem like common sense but simple mistakes are often the ones that cause the most trouble on a small business’s tax return. Mathematical errors, such as adding or subtracting incorrectly or putting a decimal point in the wrong place, can significantly skew your return, making it appear that your tax liability is much different than what it actually is. Once the IRS catches on, an audit may not be far behind. Double-checking your return before you file can help you to spot any potentially costly mistakes.

If your small business is selected for an audit

Undergoing an audit can be a nerve-wracking experience and it’s in your best interest to have an experienced tax professional assist you throughout the process. A qualified tax expert can help you with organizing your records, clarifying the information included on your return and ensuring that your rights are protected at every step of the way. In situations where an audit results in an increased tax liability, they can also offer guidance with regard to payment options, such as Installment Agreements or an Offer in Compromise. If you’ve received an audit notice for your small business, contact experienced tax attorney Jessica Grace at (612) 326-5291 today.