There’s no doubt that a small business owner has an overwhelming number of responsibilities that are all calling for your attention at once. However, being pressed for time isn’t a good thing because you tend to ignore the little things that can cause more stress in your life. Yes, we’re referring to an audit. While an audit isn’t something “little”, the mistakes that can bring about an audit are minor. The thought of an audit makes small business owners cringe inside. Although, it isn’t guaranteed that you can stop an audit from ever happening, there are some steps that you can take as a small business owner to stop it from happening in the meantime.
An audit typically involves the IRS going through your income and expenses to make sure that the amounts reported are actually accurate. During an audit, the IRS are mainly looking for; exaggerated deductions, and unreported or under-reported income. You are obligated to provide all documentation as requested by the IRS.
In order to avoid the unnecessary hassle of an audit, here are 7 red flags that should be avoided at all costs to reduce the risk of your small business being audited.
1. Having a net loss profit for 3 out of 5 years
Your business must be able to have a profit for at least 3 years out of a 5-year period. If not, the IRS will become really interested in why you’re not returning a profit but manage to stay in business.
2. Late filing and late payments
Not meeting deadlines is against your obligation and will create unwanted attention on your business, along with additional money (penalties) that will need to be paid. Always try to pay on time or at least inform the IRS that a payment will be late.
3. Shareholders who are also employees getting paid big salaries
All employees should be given reasonable salaries based on their; skills, type of industry, and experience. Paying excessive salaries simply because they’re shareholders is a surefire way to the IRS wondering what else you may be up to.
4. Prodigious Deductions for entertainment, food, etc.
The best way to prove that your deductions are accurate consists of keeping all receipts. If receipts and extensive documentation isn’t available, that automatically makes you look guilty in the IRS eyes. Especially since this is a very common method individuals used to get out of paying taxes.
5. Transferring income to tax exempt organizations such as nonprofits
This is a form of tax evasion in its finest form. Giving away money to charities isn’t an issue. However, it becomes an issue when it’s solely for the purpose of getting out of paying taxes on it. The IRS will be more than happy to send an audit your way and see if your “charitable” donations check out.
6. 100% Vehicle Business Use
Again, the IRS wasn’t born yesterday. Deducting money for business vehicle use is one of the oldest tricks in the book. If the vehicle isn’t designated for complete business use, it’s good to keep logs of mileage and the purpose of each trip.
7. Majority Cash Businesses
This is where places like car washes, barbershops, and bars have to be really careful. No matter what precautions you take, you’re always going to be under the magnifying glass of the IRS due to the easiness of hiding and underreporting income.
Small business owners are already up to their necks with busy work. However, it is important to document everything you do and keep receipts. You can even potentially create a system that only important files for compliance are uploaded to.
The last thing you need is the IRS knocking at your door for an audit. If you do receive a notice, do not ignore it like some businesses do. It’s in your best interest to contact a tax lawyer. Although these steps do not guarantee the IRS will audit you, it doesn’t hurt to try your best to prevent the hassle.