Tax Audit Flags for Small Business
Reduce Your Chances of the IRS Choosing Your Company to Review
Jan 18, 2008
The Internal Revenue Service plans to increase the number of audits of small businesses. Knowing and understanding what the IRS looks for can help you to decrease your chances of an audit, although this is certainly not a guarantee that you won’t be audited.
Some of the “red flags” the IRS looks for are:
- Handwritten, sloppy returns or those that contain math errors. If your return needs to be reviewed because your handwriting can’t be understood, it is sloppy or it contains math errors, they will look for additional errors as well. Filing electronically is a better choice.
- Large compensation for corporate officers in C-Corporations. When corporate officers have high compensation, it means lower corporate taxes. The IRS will flag returns showing high compensation for corporate officers.
- Low salaries in S-Corporations. Sometimes employees will take low salaries and then receive profit distribution, therefore avoiding payroll taxes. The IRS will flag returns showing low employee salaries.
- Using the wrong reporting system. There are two types of accounting methods, the cash method and the accrual method. Although any business may use the accrual method, not every business may use the cash method. Be sure to know if you are required to use a certain accounting method.
- Using independent contractors. Although there is nothing wrong with using independent contractors, some companies will pay people who should actually be employees as an independent contractor. If caught, companies will need to pay taxes back, plus penalties and interest. If you use independent contractors, be sure they should not really be listed as employees. In addition, for any independent contractor that is paid more than $600 in a calendar year, you need to complete a 1099 and send to the independent contractor as well as submitting to the IRS.
- Miscellaneous expenses. When completing your list of expenses for the year, avoid using a “miscellaneous expense” category if at all possible. Divide your expenses into categories such as office supplies, rent, utilities, etc. If you have a miscellaneous expense category, be sure to include only miscellaneous items and be sure to keep documentation.
- Automobile expenses. The IRS has certain regulations regarding the deductions a company can make for automobile expenses. Understand whether you need to add amounts to an employee's W2 if a vehicle is used in part for business and in part for personal use as opposed to a vehicle owned and operated strictly for business use.
Again, understanding these red flags will not guarantee that you avoid an IRS audit, however, you may be able to decrease your chances by following the IRS regulations carefully.
For information on what the IRS looks at during an audit, broken down by industry: IRS Business Tax Audit Secrets
Further Information:
Audit Risks for Home Businesses
References:
Small Business Tax Audit Secrets, Small Business Notes
Common Mistakes Can Mean Considerable Missed Savings for Businesses, Michael Minyard, Small Business Administration
Small Business Tax Tips for Avoiding an Audit, Denise O”Berry, 2007, AllBusiness
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