What Triggers an IRS Audit and How Can You Lower Your Tax Audit Odds?
IRS Audit Triggers: How Can You Avoid a Tax Audit?
For small business owners, an IRS audit can be a stressful and time-consuming experience. While the risk of being audited is relatively low, certain red flags on your tax return can increase the odds. Understanding what triggers an IRS audit and taking proactive steps to avoid these pitfalls can help ensure your small business stays on the right side of tax compliance. Therapeutic Tax Solutions specializes in small business bookkeeping, tax preparation, and tax planning, ensuring that taxes are filed correctly and efficiently to reduce audit risks. Let’s explore the most common IRS audit triggers and how to lower your audit odds.
Top IRS Tax Audit Triggers for Small Business Owners
The IRS uses a combination of algorithms and manual reviews to identify potential audit triggers. Small business owners need to be especially cautious, as certain behaviors or reporting inconsistencies can raise red flags. Certain reporting issues are more likely to attract the attention of the IRS. They can audit tax returns as far back as six years, so knowing the common flags that can trigger an audit can help you prepare your tax return more carefully.
Unusually High Deductions
One of the biggest IRS audit triggers is claiming deductions that appear disproportionately high compared to your business income. For example, if your deductions for travel, meals, or business expenses seem excessive for the income level reported, it could raise suspicion. While legitimate deductions are important for reducing your taxable income, ensure that they are reasonable and well-documented.
For more information on deductions, read our previous blog article "10 Small Business Tax Deductions that Business Owners Shouldn't Forget".
Reporting Business Losses on Your Tax Returns Over Multiple Years
Reporting consistent business losses year after year can also trigger an IRS audit. The IRS may suspect that your business is more of a hobby than a legitimate operation if you continuously report losses. This is especially true if your business expenses significantly exceed your reported income. To avoid this trigger, ensure you can prove your business is operated with the intent to generate a profit.
Incorrectly Reporting 1099 Forms
Small businesses must file 1099 forms for contractors or freelancers paid more than $600. Failure to report these payments or discrepancies between your reported income and 1099 forms received could trigger an audit. It's essential to double-check that all 1099 forms match the income reported on your tax return to avoid raising any red flags with the IRS.
Discrepancies Between Business Income and Lifestyle Can Also Trigger an Audit
If your reported business income doesn’t align with your personal lifestyle or spending, this could trigger an IRS audit. For example, if you report your income modestly but your personal spending indicates a much higher income level, the IRS may question the accuracy of your tax return.
Underreporting Your Taxable Income
Failing to report all of your business income can also lead to an IRS audit. The IRS receives copies of 1099 forms, W-2s, and other tax documents directly from businesses and financial institutions. Any discrepancies between what the IRS knows and the amount of income you report can trigger an audit.
Underreporting income is one of the fastest ways to trigger an IRS audit. The IRS uses sophisticated algorithms to compare the income you report on your tax return with the income reported by third parties, such as clients or financial institutions. If there is a mismatch, you’re more likely to hear from the IRS.
Overreporting Business Expenses Without Supporting Documentation
Business expenses are an essential part of lowering your taxable income, but they must be accurate and supported by receipts or documentation. Failing to provide proper documentation for large deductions, such as travel expenses or charitable contributions, can trigger an audit. You may also find this article helpful: "How are Fringe Benefits Taxed?"
Reporting Personal Expenses as Business Expenses
It’s tempting to write off personal expenses as business expenses, but doing so increases your chances of an audit. The IRS pays special attention to deductions that appear to mix personal and business expenses, such as using a personal vehicle for business purposes without proper recordkeeping.
Proper Bookkeeping Can Help You Avoid an Audit
Although there is no way to guarantee you won’t be audited, there are several steps you can take to lower your audit odds. By being mindful of common IRS audit triggers and ensuring accurate reporting, you can significantly reduce your risk.
Keeping accurate and detailed records is one of the most effective ways to avoid an audit. The IRS may request supporting documentation during an audit, and having organized records can make the process much smoother. Professional bookkeeping for your small business not only puts the proper organization in place, but also keeps things up to date throughout the year, making tax time much less stressful.
Keep Detailed Receipts for Deductions
Obviously, you want to do everything you can to reduce your tax liability, but any tax deductions you claim must be backed up with receipts and records. For example, if you claim a home office deduction, you’ll need to provide proof of the space's exclusive use for business purposes. Keeping organized receipts and invoices for expenses like travel, equipment, and supplies ensures you’re ready to substantiate your deductions if necessary.
Maintain Separate Bank Accounts for Business
One simple way to lower your audit odds is to maintain separate bank accounts for your business and personal finances. This separation helps prevent accidental reporting of personal expenses as business deductions and makes your financial records easier to manage.
Work with a Tax Professional
Working with a tax professional, like those at Therapeutic Tax Solutions, can help ensure your tax return is accurate and that all deductions are legitimate. A tax professional can also help you identify potential audit triggers and advise on how to avoid them, reducing the chances of an IRS audit.
Accurate Reporting and Tax Records Help You Avoid an Audit
Accurate reporting of your income, expenses, and deductions is essential to minimizing your audit risk. Even simple mistakes on your tax return can raise red flags.
Double-Check for Errors
Errors, such as typos, miscalculations, or incorrect figures, can trigger an IRS audit. Be sure to double-check your tax return for any discrepancies or mistakes before filing. Tax preparation software or working with a professional can help ensure your return is error-free.
Report All Income Accurately
It’s important to report all income, including payments from freelance work or side businesses. Even small amounts of unreported income can trigger an audit if the IRS notices discrepancies between your tax return and the 1099 forms or other reports it receives.
FAQs Regarding Tax Audit Triggers
What are the top IRS audit triggers for small businesses?
Some of the most common audit triggers for the Internal Revenue Service include reporting unusually high deductions, consistent business losses over several years, and failing to report all income on your income tax returns.
How can I reduce my chances of being audited?
You can reduce your audit odds by keeping detailed records, maintaining separate business and personal accounts, and ensuring your tax return is accurate. Working with a tax professional is also a great way to lower your risk.
Can claiming the home office deduction trigger an audit?
While claiming a home office deduction is legitimate for many small business owners, improper or inflated claims can raise red flags. It’s important to follow IRS guidelines and ensure that the space is used exclusively for business purposes.
What should I do if I’m audited by the IRS?
If you’re audited, remain calm and provide the requested documentation promptly. A tax professional can help you navigate the audit process and ensure that you comply with IRS requests.
How can a tax professional help me avoid an audit?
A tax professional can ensure your tax return is accurate, help you avoid common audit triggers, and provide guidance on maintaining proper documentation for your business. This can reduce your odds of being audited by the IRS.
Ready to Protect Your Business from IRS Audits? Apply to Work with Us Today!
Avoiding an IRS audit starts with accurate tax preparation and expert guidance. At Therapeutic Tax Solutions, we specialize in helping small businesses like yours navigate the complexities of bookkeeping, tax preparation, and tax planning. Let us help you minimize your audit risk and ensure your taxes are filed correctly. Apply to work with us today and take the stress out of tax season!