Slipping away from what triggers an IRS business audit is something you can think about, plan, or dream of, but impossible to avoid, especially when there’s an increased likelihood of the presence of discrepancies between what has been reported and what has been filed for the tax returns.
You’re already aware of the fact that deeply-rooted and mature industrial corporations have to go through federal and state audit representation, but there are certain financial factors in small businesses that attract the IRS audit triggers. Sometimes, these audits are totally random. You’ll find your stuffed mailbox with a notice from the officials, and you’ll owe them a detailed explanation with documents and related proof.
Even if your previous records are as clear as crystal, demonstrating negligence towards such letters is what triggers an IRS business audit. Some unfortunate turns may also lead you to face IRS audit penalties.
How Can You Prepare for Being Audited?
Calm your nerves down – this is something you can do to avoid panicking because, after all, it is just a notice, not a death sentence!
The best way to prepare for an IRS tax audit is to respond to their notices in an appropriate and timely manner. Try your best to use a formal, polite, and cooperative tone while doing written or verbal communication. In case your firm has a hefty sum of money involved, you definitely need to contact a professional tax consultant who can sail you safely from the prospective sanctions with heavy fines.
Step by Step Guide: What Triggers an IRS Business Audit?
Being a business owner, you need to understand what triggers an IRS business audit because there might come a time when your return will become one of those attractive ones that attracted your record for a closer inspection. The following are the top provocative factors that trigger an IRS business audit.
1. Cash-Heavy Business
You’re prone to get audited if you’re generating hefty revenues and your business deals excessively in cash. IRS aggressively targets because it has found a great tendency among cash-business owners to forget to declare some cash income that needs to be reported. Typical examples of such businesses include spas and salons, car washes, convenience stores, restaurants, and self-service laundries, also known as laundromats.
2. Limitless Monthly Income
If you’re earning more than a million dollars per year, you will definitely be audited. Conversely, the odds of getting audited are reduced to half if you earn up to or less than half a million.
3. Mathematical Errors
A simple mathematical error is what triggers an IRS business audit the most and is one of the easiest mistakes you can make while filing tax returns. Addition or subtraction mistakes will likely get caught. They are flagging your returns even if that mistake is in the favor of the Internal Revenue Service.
As the efforts of manual calculations have been greatly reduced with the launch of different accounting and financial software that perform such estimates in no time, the chances of mathematical errors have been totally eradicated, shielding your reputation from being one of the red flags.
4. Home Office Deductions
If a part of your home is dedicated to serving as your private office or workstation, deducting some amount of that space from your income tax within the legitimate premises is permissible, and it saves you a lot of money. However, IRS may challenge you on this to check the legitimacy of your finances.
5. Abrupt Ascend in Income
The IRS is always curious to learn the reasons behind the drastic increase in your annual income. For instance, you earned $500,000 this year, but your previous yearly income was $200,000. It doesn’t imply that you should put a full stop to your earnings, but always be mindful of documenting even the minor details so as to save yourself from unwanted and unexpected audits and their penalties.
6. Improper Classification of Employees
Sometimes, many business owners misclassify their employees as independent contractors for many reasons, such as reducing the cost of business insurance and labor costs and not paying certain small business taxes. Surprisingly, what triggers an IRS business audit also includes inappropriate ways to divide your working personnel into several classes.
7. Misuse of Vehicle for Business
Owners of business startups are entitled to claim auto expenses on their taxes that are relevant to their business. Mileage logs and calendar entries that include business purposes require proper record maintenance because taking these deductions is a way of increased exposure to being audited.
8. Personal and Professional Expenses
Justify a true business purpose for the deductions, whether you’re claiming traveling, entertainment, or any other kind of activities. Ensure the alignment between your business and these expenses. It is highly advisable to avoid deducting the amount spent on household items and miscellaneous products for personal use, such as buying presents for your loved ones.
9. Consistent Money Loss
Some people try to nullify or give up on what has been spent on leisure activities as if they’re claiming expenses as deductions for legitimate businesses. If your company doesn’t show a profit for the majority of the last few years, the IRS may call you in to determine whether you’re actually running a true business venture.
The Bottom Line
The importance of organizing and maintaining these records is crucial to withstand such trembly times, even if you’re confident in your business dealings. Besides, it is quite easy to provide the required documents to back up your finances and satisfy the auditors. What triggers an IRS business audit may strike fear in your heart, but the reality is that these stimuli affect a smaller number of tax returns, ranging from a few hundred out to millions.