While a tax audit sounds like a frightening and stressful situation, it doesn’t necessarily spell out trouble for your business. An audit is simply an examination of a tax return by the Internal Revenue Service, ensuring that your filings meet federal tax code. Being audited doesn’t necessarily mean you are in trouble; it just means the IRS wants to know more about your claimed income and deductions.
However, being audited can be detrimental to your business, as audits are often time-consuming and costly. Although some audits are handled in a timely manner, others can lead to additional expenses for accountants or audit representation, which could put some businesses in a tight financial situation. There can also be severe penalties if mistakes or problems are found.
For these reasons, it is important to avoid a tax audit by being careful to take certain steps to file responsibly and completely while avoiding common audit triggers.
Steps to Take to Avoid an Audit
There are certain steps that your business can take when preparing and filing tax forms that can help prevent an audit. Be sure to:
- Educate yourself on tax forms and laws. Many mistakes can be avoided simply by being informed of the law and knowing exactly what needs to be documented and reported. This is the most efficient and effective way to protect yourself from an audit.
- Double- and triple-check your numbers. Errors in data entry are very common. They are also very preventable. Always go over your income, bank statements and all financial paperwork to make sure the numbers match up.
- Gather all of your correct forms before filing. It can be easy to forget or miss a form. Check the IRS website for forms and publications that are relevant to you and your business.
- Be truthful and honest. If your numbers look unrealistic, the IRS is likely to think you are lying and not reporting all of your income. This is most important for self-employed workers, so keep all of your receipts and report everything, even if it seems small and unimportant.
- Keep good financial records, and save receipts, forms and checks. These will come in very handy in proving your claims. If you’re looking to streamline your “receipts in a shoebox” system, consider using a service like QuickBooks, which allows you to scan and/or digitize your receipts.
- Find a reliable and trusted tax preparer. The IRS has a recommended list of steps to take to choose a reliable tax preparer.
- E-file to reduce your chance of an audit. E-filing reduces your risk of an audit because all numbers and errors are checked through the online software before submitting. This software can also often predict the likelihood of an audit, so you can clear up any issues before filing.
- If you don’t have documents or receipts to prove your deductions, don’t report them. You must be prepared to back up your claims. Sometimes, third-party testimony or other forms of documentation will be accepted, but it isn’t smart to rely on these methods.
Common Triggers to Avoid
Many common factors contribute to a higher likelihood of being audited by the IRS. Many of these triggers can be avoided easily by filing on time, being honest and signing all your forms. Certain flags or actions bring extra attention from the IRS and are best to avoid when possible. Try to avoid these common triggers when filing:
- Missing tax deadlines. This makes you look non-compliant.
- Not signing all of your forms.
- Too many deductions. Unrealistic deductions raise flags; most people don’t give a large percentage of income to charity.
- Handling a lot of cash and tips. The IRS is likely to suspect “skimming” if you handle a lot of cash and don’t report a realistic amount.
- Having a lot of independent contractors, or improperly identifying employees as contractors.
- Schedule C filing often raises flags because of the nature of the claims. Keep perfect records if you own your own business.
- Incorrect personal information. This may look like you are trying to hide your identity.
What to Do if You Are Audited
Regardless of the steps you take to avoid an audit, you could still have to face one at some point in time. It is impossible to predict who will be audited by the IRS and when. If the unfortunate event of an audit occurs, be prepared to gather all of your necessary forms, receipts and documents that relate to your income and deductions.
You may choose to meet with your accountant or a tax professional to come up with a plan. Overall, if you are prepared with your records and expense logs, then handling a tax audit should only be a small hiccup in your regular routine.