As a small business owner, the thought of getting audited by the IRS is probably enough to make your blood run cold. But did you know that your chances of getting audited are slim? In fiscal year 2019, an IRS report showed that only 0.45% of Americans were audited for their income tax returns. That’s 0.14% less than the year before. This amount is also significantly less than audits performed just 9 years ago in 2010 (1.1%).
While it seems like good news, the truth of the matter is this decrease is actually more driven by budget cuts in the IRS rather than trust in taxpayers. Yet even with the small chance of being audited, it’s important to remember: you’re never completely immune. The chance is always there — especially with companies that raise red flags.
Each year, you should take steps to actively avoid drawing attention. In addition to hiring a professional for your small business tax preparation needs, you should also learn how to stay comfortably “under the radar.” Both of these tips are key to avoiding lengthy, frustrating IRS audits.
Here are five of the most common reasons your small business may be audited by the IRS, and how to avoid making these common errors.
1. Unreasonably High or Low Salaries for Shareholders Who Are Employees in S-Corporations
If you’re providing unreasonably high salaries for any shareholders who are also your employees, you’re treading on thin ice. “Unreasonably low” salaries for S-Corp owners are also a big red flag. Any amounts paid to a shareholder employee must be considered “reasonable compensation.” If they are not, you’re more likely to be audited.
To keep this from happening, be careful when issuing salaries to shareholder employees. Make sure salaries are reasonable based on the skill level of the employee, your geographic location and the industry your business is in. This may require some research on your part, but it’s worth the effort to make sure you’re abiding by regulations.
2. Claiming Too Much Business Use of a Vehicle
When you have a vehicle that is not designated for business use, never claim 100% business use of the vehicle on your taxes. If you do, you’re raising a red flag to the IRS. If the vehicle is clearly used for both personal and business use, always be honest in its usage. Additionally, you should maintain detailed calendar entries and mileage logs for all business uses of the vehicle, to make business tax preparation easier each year. The goal is to hope that you aren’t audited, but to be prepared for an audit just in case. We strongly recommend the automated mileage app “MileIQ”
3. Reporting Too Many Net Losses Too Frequently
If you report too many net losses too frequently, you add to the reasons your small business may be audited. In general, it’s best to report net losses no more than two times every five years.
To keep yourself in the clear, follow the business expenses guide found in the IRS publication 535. It currently goes over legislation enacted on December 20, 2019, regarding business expenses and how to claim them on your tax returns. The form is updated annually to reflect the most current legislation. Refer to the publication (or consult your tax planning professional) when performing business tax preparation to find out what common business expenses are and are not deductible.
4. Excessive Deductions for Entertainment, Business Meals and Travel
Some people take a lot of liberties when claiming business expenses on their tax filings. If the IRS notices an unusual amount of deductions for business-related travel, meals, and entertainment, you may be selected for an audit.
You may be able to prevent unwanted attention by being modest about any expenses you incur on your business trips. You should also make sure you are honest and never claim something is a business expense if it was clearly not done for business reasons. If you really do have a lot of valid deductions for business travel and entertainment, make sure you hang onto all your receipts and keep detailed records. Don’t ever exaggerate or estimate your expenses either. Accuracy is essential when it comes to business-related deductions.
5. Consistently Filing Tax Returns Late
The IRS notices when you file your tax returns late. If you’re trying to stay under the radar, filing late is not the way to do it. You’ll also draw negative attention to your business if you consistently pay any owed taxes late. In addition to increasing your risk of an audit, filing and paying late also triggers interest and penalties. If you absolutely need to have an extension, ask for one before the deadline.
To get on the IRS’s good side and minimize your risk of being audited, always file and pay your taxes on time (or early!). It’s wise to put money aside throughout the year to put toward any owed taxes. That way you won’t have to scramble to come up with the cash to pay your taxes at the last minute.
Avoid an Audit: Schedule Small Business Tax Preparation Services
Filing your own taxes can be stressful. It also puts you at a higher risk of making mistakes and unintentionally raising those dangerous red flags. To avoid gaining unwanted attention — and reduce the number of reasons your small business may be audited by the IRS — consider hiring professional small business tax preparation services. To schedule your appointment with Pine & Company CPAs, get in touch with us through our convenient online form.