How to Avoid a Business Tax Audit

how to avoid a business tax audit

Estimated reading time: 3 minutes

The mere thought of the word “audit” can send chills down the spine of any small business owner. IRS tax audits can pinpoint errors relating to income, deductions, credits, and business records. If discrepancies are found and back taxes are owed, they must be paid on time to avoid additional taxes, penalties, or interest.

If you own a small business, you have about a 2.5% chance of getting audited each year you file a business tax return. Although the probability of being audited seems relatively low, you cannot afford to be ill-prepared. This Balboa Capital blog article will teach you how to avoid a business tax audit.

Avoid mistakes on your tax form.

Mistakes on tax forms are relatively common and can raise a red flag with the IRS. So, make sure your tax form has accurate information everywhere, with no spelling or mathematical errors. Incorrectly writing your business name, tax ID number, business address, business income, etc., can trigger an IRS audit.

Don’t claim too many expenses.

The IRS always looks closely at small business tax deductions to ensure companies adhere to the rules. You should avoid paying too many expenses for vehicles, travel, meals, and entertainment. Instead, keep all receipts for your business’s expenses in an organized file and present them to your accountant or financial adviser.

Report 100% of your income.

Under-reporting your business income is another tax “no-no.” If you do not pay the business taxes you owe, you might have to pay them back, with interest or late fees, in the future. The IRS has many ways to determine if you are under-reporting your business income.

Checks and credit card, and debit card transactions can be easily traced. If your small business conducts cash transactions, the IRS can compare your income against your cost of living or check your bank balance with your reported losses. So, report all of your business income to avoid penalties. And don’t forget to report the sales tax amount that your small business collected.

Don’t report losses year after year.

You started your small business to make money. If you are not generating profit in three out of five years and reporting losses on your tax return, the IRS will view your venture as a mere hobby. This means you can only deduct qualifying business equipment and expenses up to a certain amount that you make from the hobby.

Own a home-based business? Follow the rules.

If you run a small business from home, there are specific rules you need to follow. First, you can only use your home office area for business purposes. You and your family members are not allowed to spend time in that space to do things like watch television, use your computer, or enjoy a meal. If you have a tax audit, you must prove that you only use your home office for business.

You have a tax audit; now what?

If the IRS decides to audit your small business, it can be done via mail, at an IRS office, or on-site at your office. Most small business tax audits are completed in the field, so do not be surprised if the IRS wants to audit your tax return at your place of business. The IRS will notify you of which documents and information will be needed. You will also need to thoroughly explain your company’s accounting systems and protocols.

If needed, you may have your accountant present at different tax audit stages to represent you and answer questions relating to IRS laws and procedures. Most IRS business tax audits start in the same year that returns are filed, and they are typically completed in less than one year. If you end up owing more taxes, the IRS is reasonably flexible in making payments. For example, the IRS offers extensions, monthly payment plans, and deferred payment plans.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.