A tax audit can be a daunting thought, but in reality, your chances of being audited are actually very small. Last year, less than one percent of income tax returns were audited by the Internal Revenue Service. Despite this statistic, it is important that you have a clear account of your earnings and expenditures ready in case you are audited, and the responsibility for this falls on the small business owner. Your chance of being audited can vary depending on your income bracket.
What is an IRS Audit?
An IRS audit is a review of a business’s or an individual’s financial information and accounts. The purpose of the audit is to check that the reported information is correct according to the tax laws. The audit also verifies whether the reported amount of tax is correct.
Red Flags To Avoid Chances Of Being Audited
Multiple Net Losses Year-After-Year
You are more likely to be audited if you report net losses in more than two out of the five years of operation. Sole proprietorships are more at risk than other small business. A sole proprietor reporting losses will increase their likelihood of being audited. Reassess your income and deductions to make sure everything is in order before proceeding to file a loss, and you should also be prepared for an IRS audit just in case.
Consistently Filing Late
Late filing of a tax return can incur penalty fees, and it can also encourage attention from the IRS. Don’t wait until the last minute, get your taxes in order as soon as it is possible to do so to ensure your tax return is always on time and that there is no reason for an IRS audit.
Uncharacteristically High Salaries
Small business owners who pay high salaries to shareholders of their business attract attention from the IRS. Learn more about fair salaries for your line of business to avoid this. In addition to this, if a business fails to deposit employment taxes on time, it may be issued with a trust fund recovery penalty.
Too Many Deductions
Carefully choose your deductions to ensure you aren’t claiming on expenses that may be questioned. Ensure that each deduction is a genuine business expense. Make sure you are being consistent by comparing deductions from previous tax return years. The IRS states that a deduction must be ‘ordinary and necessary’ to business to qualify for a deduction. Avoid too many deductions and you can avoid an IRS audit.
Giving Large Sums to Charity
Charity money incurs no tax, and businesses sometimes give money to charity for this purpose, this is considered an abuse of the tax code. If you do want to give to charity, don’t make a sudden large donation, donate in small amounts regularly.
Business Vehicle Use is Excessive
You can expect scrutiny from the IRS if you claim 100% business use of a vehicle. You must be able to prove that every trip made was related to business in order to confidently do this. Keep accurate representations about percentage used for business purposes. Keep track of mileage, dates, meetings, etc.
A business that deals mostly in cash, will get the attention of the IRS as it is harder to verify cash transactions. Large cash transactions such as the purchase of a company vehicle or business equipment, or an investment in property can also cause concern. Use credit or debit cards to create a paper trail and to lessen your chances of an IRS audit.
Calculation Errors and Rounded Numbers
Use exact figures to ensure that the IRS doesn’t suspect that you are making expense estimates.
If you are filling a 1040 form for 2018 as a sole proprietor, ensure the details are all correct. It is thought that the use of this type of comprehensive tax form can increase the chances of a tax audit.
Failure to Report Taxable Income
Business owners must report all income made in the United States, including cash payments, and that stored in offshore bank accounts.
The Next Steps
Preparing a tax return can be time-consuming and stressful, it also leaves the door open for errors. By hiring a tax advisor you can ensure that your returns are thorough, and filed on time, every time. At IRS Solver we are experts in tax returns and tax audits. Contact us today to find out more about the services we offer in conjunction with filling IRS tax forms for 2018 for your business income taxes.