Creating a profitable small business requires dedication and commitment, but long-term success also involves regular attention to routine obligations like bookkeeping, submitting taxes, and budgeting.
Sometimes, certain habits or behaviors related to these customary responsibilities may trigger an IRS audit, which no business owner wants to experience.
Is an IRS audit inevitable, or is it possible to avoid one entirely? Let’s discuss some habits that may trigger an IRS audit and how your small business can avoid those triggers.
1 Too Many Large Tax Deductions
Businesses are afforded some excellent tax deduction opportunities, which make it possible to conduct business even when you don’t have a substantial amount of startup funds or liquid capital.
However, the IRS may become suspicious when you take an abnormally large number of deductions of a particular type. The IRS allows deductions for items like meals, entertainment, and travel, but those expenses must make sense within the context of your business. For example, we once provided the accounting and Quickbooks Online services for a plumbing company, where almost 50% of their operating expenses were for “Business Promotions and Entertainment.” Hmm. Seems unlikely.
2 Income Reporting Discrepancies
Income reported on your taxes should match the information on official tax documents you receive like 1099s and W-2s, which your customers report independently to the IRS.
For example, the IRS will notice the discrepancy if a client issues you a 1099 for $23,000, but your tax return says that you received just $13,000 for your work. QBO and similar accounting systems are a tool – that with competent advice – can help avoid these discrepancies. Or, even more often we see that IRS Payroll forms 941 (quarterly returns) do not add up to what they see on your Profit & Loss statement. This is an easy way to get IRS attention.
3 Business Losses Year After Year
We’ve all heard about huge corporations posting giant losses year after year, but can the average small or medium-sized business post repeat losses and avoid scrutiny by the IRS? The truth is, the IRS may want to classify your business as a hobby rather than a business if tax losses are posted year after year.
What can this mean for your business? When you have a hobby rather than a company, you lose access to your business deductions, meaning your “hobby” may become much more expensive in the long run.
If you are incurring losses for many years in a row, it may be better to occasionally report a small profit. A good accountant can help with this!
4 Frequent Large Cash Transactions
Conducting a cash transaction over $10,000 normally requires that the funds recipient notify the IRS, and this notification is required whether regardless of whether it’s for a business or a personal purchase. For example, if you buy a car and give the dealership more than $10,000 in cash – even if it’s just for taxes and fees – the dealership must inform the IRS about the payment.
There isn’t anything negative about this reporting; it’s a routine submission. Still, when you report these transactions as business deductions, the the IRS may take a closer look at your operations and decide to conduct an audit.
To avoid any appearances of impropriety, complete and accurate recordkeeping should be maintained with some type of program, whether it’s Microsoft Excel or QuickBooks desktop, or even more popular these days, Quickbooks Online.
5 Incomplete and Tardy Tax Filings
The IRS is a stickler for timelines, and failing to submit your tax returns on time, particularly if you submit them late year after year, may cause the IRS to train its eye on your business and order an audit. At a minimum, expect a “late filing” penalty, even if no taxes are owed.
An incredible number of data points are required for filing accurate and complete taxes. Receiving assistance from an income tax advisor (who is often with the same firm that does your accounting, like us!) helps ensure that nothing is forgotten during the filing process; mere humans are unlikely to satisfy the many IRS requirements in this area.
Try to avoid the old-fashioned method of stuffing everything in a shoe box and then asking someone to weed through it at the end of the year. Take advantage of all the conveniences that modern tax accountants, professionals and programs can offer. For example,, Quickbooks Online has a feature where receipts can be scanned in from your mobile device.
What Happens If You Do Experience an IRS or state Income Tax Audit?
It’s not the end of the world if you receive notice of an IRS audit. Keeping excellent records is the best way to satisfy any request from the IRS for documentation during the audit process.
Another way to make the audit process more manageable is to partner with an expert small business bookkeeping and accounting company like – us!.
You’ll find expert QB and accounting help with QB-LA whether you’re setting up your first QuickBooks online accounting system or just want to be sure that you’re utilizing all of the best features for your business. Send us a note, do the “Quick Contact” thing below, or just call us at 310-281-6161.