You have received the dreaded tax audit letter for your business. Maybe it is your first time, and you do not fully understand what tax audit entails.
A tax audit is an assessment of the validity of the information you provided in your tax returns. If the IRS notices an inconsistency in your report, they may schedule a tax audit for your company. Usually, there is nothing to worry about. All you need to do is to provide all the information that the auditor is asking to enable them to determine if you are in compliance.
Some flags that get your business shortlisted for auditing
Running a small business is not easy. You strive to do everything to ensure that your records are accurate, including your taxes. Unfortunately, this may not be enough. You may still find yourself on the IRS list, with the burden of proving that your earnings and expenditures are as you filed them. Some situations that could make your business a candidate for a tax audit include:
- Recurrent losses year after year
If your business has reported net losses in two out of five years of operation, you should prepare yourself for an audit. You may need to check your incomes and deductions for any excesses. Ensure you support all your deductions with proper documentation.
- Late filing
Apart from the penalty fees that you will have to pay for late filing, you will also draw attention to your business. When you want to stay away from the IRS, you need to become invisible by filing your returns within the deadline. If you consistently file your returns late, you can easily land in the list of firms to be audited. Start putting your documents together at the start of the year to make timely filing easier.
- Paying very high salaries to employees
You should balance between the shares and salaries that an employee holds. The IRS usually has its eye on shareholders who also earn high salaries. You need to be familiar with the average salaries that employees like yours earn in the industry. As a small business, a problem could also arise over the years as you inevitably grow. When a business grows, employees expect a salary increase. The salary increase can attract the attention of audit bodies.
- Many deductions
Too many deductions can make you a tax audit candidate. Before you make a deduction, consider if it qualifies in the first place. Compare your deductions over the years and check for consistency. If you are new in business, you can hire a consultant for guidance or look for relevant information online. The ground rule put in place by IRS is that an expense must be āordinary and necessaryā to qualify as a deduction.
- Donating large sums of money to charity
A sudden shift to giving more money to charity can act as a red flag for your business. Some businesses give money to charity to evade tax, which is a tax offense. To escape this offense, make reasonable and consistent deductions every year.
- Making cash transactions and using digital currency
Digital currency such as bitcoin is new and not many people have adopted it. You can avoid transacting primarily using digital currency until it gets more formal. If you do a lot of business in cash, especially big business, you may also get audited. It is much harder to verify cash transactions such as the purchase of a new car or investment property. It is best to use a debit or credit card whenever possible. If you go cash, record your transactions in detail for ease of future reference.
- Excessive business vehicle use
Claiming 100% business use for your vehicle will attract the attention of audit bodies. You need to choose between the actual expense incurred or the IRS standard mileage rate. If you claim 100% depreciation, you should provide evidence of all the trips you have made with the vehicle all year long. Your vehicle expenses should be an accurate representation of how you have used the car for business purposes only. Business use consists of activities like meeting clients, conducting research, and posting mail.
- Mathematical errors
To be safe, work with exact numbers and avoid rounding up or using averages. Ensure your additions and subtractions are also right.
Additionally, report all your taxable income. Leaving out any source of income will get you audited.