If you’re a small business owner, the mention of the word ‘audit’ can scare you. Audits can be pretty stressful. But audits can trigger next-level stress and anxiety for a small business owner who doesn’t have much to lose.
Have you ever wondered why the Internal Revenue Service (IRS) audits some small businesses and spares others? What is their basis for choosing which business they would audit? Well, if the IRS is going to audit you. Then it’s highly possible that any of your practices may have triggered them to do it.
This blog lists small business audit triggers that many business owners often overlook. Because they don’t realize that it could be what’s making the IRS bring you on their radar.
You Report High Income on Schedule C
If you’ve registered your business under Schedule C (sole proprietorship). Then you need to be very careful about the income you report. Because the audit rate for small businesses under Schedule C that reported an income of more than $1,000,000 is 3.23%. When compared to businesses with similar income. But they didn’t file Schedule C. The IRS audit rate for small businesses that didn’t file Schedule C is about 0.6%.
If you report an income of more than a million dollars when you registered your business as a sole proprietorship. It can trigger the IRS, and they may decide to audit you. Yet, the chances of the IRS auditing you are also high if you don’t report all your income, average out your income or round up your income.
You Deal Mostly in Cash
If most of your business deals are done in cash, the chances that the IRS will audit you are high. As per IRS, businesses that deal with lots of cash don’t always report all of their cash income which would be taxed if reported. For this reason, the IRS targets cash-heavy businesses more often to ensure that they report all of their income and aren’t trying to skim their taxes.
Too Many Deductions in Business Expenses
Legitimate business expenses (ordinary and necessary) are tax deductible. It means you can subtract these expenses from your business’s gross income when you report your income for tax filing purposes. If you report too many tax-deductible deductions, it may trigger the IRS and make them suspect that you’re deliberately trying to reduce your tax payable.
Some common tax deductions that small business owners often claim include internet bills, home office expenses, vehicle use, and travel costs. Any disproportionality in tax deductions will trigger the IRS to audit your business and ensure that you aren’t playing them around in an attempt to lower your tax payables.
Claiming Business Loss Every Year
Another major small business audit trigger is claiming your business is in loss every time you file a tax return. Losses are common for small businesses, but if a small business reports losses year after year, the IRS may suspect your business is legitimate. When the IRS audits you, you’ll have to keep documentation ready to show your business expenses and revenue to show that your business expenses exceed revenue and that the numbers you’ve reported are correct.
Mathematical Errors in Calculations
If you’re a small business with only a very small revenue stream, you may think you can file your tax returns independently. Many small business owners don’t spend money on hiring professionals for tax filing, and that’s one of the biggest mistakes that can trigger the IRS to audit you. Even the smallest mathematical errors in calculations when reporting your expenses and revenue when filing tax returns won’t be taken lightly. The IRS will see it as a red flag and might audit you to obtain accurate numbers themselves.
Irregular Tax Returns
If you file tax returns for one year and then stop doing it for a few years because your business is in loss, the IRS might come in to audit you when you file tax returns again after a gap of a few years. Every business, big or small, has to file tax returns, whether they’re in loss or profit. If you’re irregular with filing your tax returns, the IRS might call you in for an explanation and may even audit your business to clear any doubts about your business’s legitimacy that they may have.
Reporting Big Changes in Income
If you report a million dollars in revenue one year and 3 million dollars in revenue the next year, the IRS may want to see for themselves what caused such a big surge in your income. It doesn’t mean you shouldn’t make money when you can; it just means everything should be documented so that you can prove your income.
Similarly, if you report massive losses one year after you reported a significantly profitable business the previous year, the IRS might be interested in looking into what went wrong. In short, any major, noticeable changes in your income and expenses won’t go unnoticed.
Not Classifying Employees Correctly
If you classify your employees as independent contractors to save money on employee insurance and certain small business taxes, be ready to get an audit notice from the IRS. You must classify your employees correctly. If you’re classifying many employees as independent contractors, you should have documented proof of them being in a contractual agreement with you. If you fail to provide proof, it’ll show your attempt to save money, and the IRS won’t take it lightly.
Improper Distinction between Business and Personal Expenses
If you include personal expenses as business expenses, you might raise the IRS’s attention. It’s very important to keep your business and personal expenses separate so that there’s no confusion regarding deductibles. You should have receipts for all your business expenses. If you’re reporting an expense as a business expense but fail to show how that expense is related to your business, you’re in trouble.
Filing tax returns is crucial, and you can’t afford to make any errors. It’s best to rely on a tax professional for the job.
However, if it’s already too late and the IRS has already notified you that they’ll audit your small business. Then you should immediately get in touch with a tax lawyer to help you deal with the IRS the right way.
Visit Spirit One for more information on tax laws.