Published on: June 26, 2020

A Small Business Owner’s Guide to an IRS Tax Audit

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    One thing that can give you sleepless nights is a tax dispute. You don’t want any red flags in your return that would trigger an IRS tax audit. An IRS audit investigates the accounts and financial documents of a business or individual to verify that they have filed the correct tax returns.

    The IRS picks candidates for a tax audit randomly, and the chances of being selected are relatively low. According to government data, the IRS reviewed only about 0.5% of the returns filed in 2017. However, some signs can compel the revenue service to launch an audit on your records. This guide focuses on four areas:

    • The triggers of an IRS tax audit
    • What you need during the audit
    • Tips on how to pass the audit
    • How to prevent future audits

    Let’s get started!

    Triggers of an IRS Tax Audit

    Many elements of your return that can pique the curiosity of the IRS and lead to a tax audit. Below are some examples.

    Misreporting Income

    The income on your W-2 and 1099 forms should match what you indicate on your return. If you declare zero income, make sure it’s true. Failing to file altogether makes things worse.

    High Income

    In the fiscal year 2017, the IRS audited 0.2% of taxpayers who earned below $200k and 0.8% of those earning between $200k and $800k. The figure shot up to 4.4% for individuals with an income of over $1 million. High income can lead to an audit.

    Not Reporting Your Corporate Salary

    If you own a C-corporation or S-corporation, you have to pay yourself a realistic salary before making non-wage distributions. Your return can call for an audit if you submit it with unreasonably low or high officer wages or none at all.

    Abnormally High Charitable Deductions

    The government is keen to reduce the number of taxpayers who itemize their charitable deductions. Additionally, the IRS is scrutinizing claims for deductions that look unusually high for an individual’s income.

    Home Office Deductions

    Home office claims are legitimate, but the office must be a space dedicated to work and nothing else. If you claim a home office, the IRS might want to confirm that your office meets the requirements according to tax laws.

    Claiming Losses Continuously

    It’s usual for startups to record losses for some time before breaking even. If you claim business losses for several years, the IRS can suspect that you are claiming deductions dishonestly.

    Incorrect Identification Information

    Inconsistent identification details can lead to a tax audit. An example is a return with a wrong social security number or conflicting numbers on the return and source documents.

    Claiming Your Car as Business Vehicle

    If you own a car but use it for business, you can’t report all your automobile expenses as business overheads. You can only do that if your organization owns the vehicle, and the business name appears on the title.

    Getting Ready for a Tax Audit

    The IRS notifies you that they will be auditing your taxes via telephone or mail. The notice includes information about what the auditor will inspect and the papers you will need to present.

    Once you receive the audit notice, you have 30 days to respond. It’s advisable to do so quickly. If you owe the IRS, for instance, delaying will only accumulate more interest on the amount.

    Understand the problem and produce copies of documents of the year in question. If you can’t trace some of them, request for duplicates immediately.

    Among the documents that the IRS might need include:

    • Previous tax returns
    • Retirement account records
    • Mortgage statements
    • Pay stubs
    • Vouchers and receipts
    • Brokerage statements

    Working with a tax attorney can make the process smoother. The professional will advise you accordingly and offer an IRS audit defense if necessary.

    Tips on Passing a Tax Audit

    A business tax audit can be disturbing, but your preparedness and conduct can mold the outcomes. Consider the following tips.

    Be Prepared

    As we have already said, the IRS will give you time to gather the necessary records. Download the financial and accounting files for the audit year from your accounting platform.

    Be Professional

    Be punctual or arrive earlier, dressed professionally without overdoing it. More focus will be on your financial records, but showing up in lavish clothing or a luxurious car can make the auditor scrutinize your taxes deeper.

    Exercise Your Rights

    You have a right to representation. Let a tax expert such as your bookkeeper, tax attorney, or certified public accountant accompany you. Since they understand accounting and tax matters better, they will answer the auditor’s questions quicker and more comprehensively.

    Be Courteous

    IRS auditors meet all sorts of characters, some of whom cause unnecessary quarrels. Courtesy makes things smoother for everyone. Be careful not to appear like you’re asking for favors.

    How to Reduce the Chances of a Tax Audit

    There is no way to prevent IRS tax audits altogether, but you can reduce the probability as follows:

    A Small Business Owner’s Guide to An IRS Tax Audit

    Always file Your Returns

    Whether you owe zero taxes or you had no income, you must file a return. It will help the IRS to understand why you shouldn’t pay.

    Be Honest

    Be prepared to validate any claims you make on your return, whether it’s business travel, meals, or entertainment. Similarly, don’t withhold information like interest paid or dividend earned.

    Prepare Neat and Legible Records

    Your handwriting should be readable to facilitate the smooth processing of your return. Enter numbers in the correct boxes and avoid scribbling.

    Hire a Competent Tax Preparer

    A preparer who makes errors or cuts corners to reduce your tax can lead to the IRS auditing you. Emphasize professionalism when hiring.

    Minimize Round Numbers

    Excessive use of round numbers can make the IRS doubt your figures. Rounded numbers are frequent when creating estimates, and the revenue service knows it. For instance, $300 when the precise amount is $297.

    Get Help With Tax Audit

    An IRS tax audit can cause stress, especially when you aren’t a tax expert. Fortunately, an experienced tax attorney can help identify the reason for the inspection, prepare you for the appointment, and offer tax defense.

    If you receive an IRS tax audit notice, contact us immediately for professional assistance.

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