Simple Mistakes Can Trigger Audits
The current tax filing system is not intuitive, and it's very easy to make mistakes. Sometimes the IRS will flag your account just because you've made a simple mistake on your Social Security number or made a mathematical error. In some cases, the IRS will only focus on this error and not require a full audit. But if other triggers are present, the IRS may insist on a full review of your business to ensure that there's nothing else that's been misstated. Always double-check your tax forms to make sure that the information is correct. Using trusted software or another person whom you trust to review your return can help you avoid an IRS audit.
Continuous Schedule C Losses
When you're running a sole proprietorship or partnership, you can sometimes claim your net losses to offset your tax payments or save them for the following year's deductions. However, if you continue to claim net losses without net profits, the IRS will take notice. As a general rule, the IRS allows you to claim net losses in profit-seeking businesses only a limited number of times within a given period. That doesn't mean they won't come check your business before that time, but if you show losses year after year, you'll likely attract attention and could wind up with an IRS audit and possibly a loss of your business deductions. If you can’t make a profit, the IRS may classify your business as a hobby rather than a business.
Excessive Expenses and Business Deductions
In general, business deductions and expenses won't get you flagged, but excessive expenses for luxurious items or items that are clearly unrelated to your business will come back to bite you. Travel and meal expenses tend to get the most attention from the IRS, as do luxury items like televisions, exercise equipment, video game consoles, and other similar items. Often, business owners try to use business expense claims to offset personal expenses, which can cause problems for your business.
To protect yourself, save your receipts and document why they were valid business expenses. If, for instance, you are entertaining a client, write down the client’s name on the receipt as well as the purpose. Otherwise, when you get to the point of an audit, you might not be able to remember why it was related to your business. This, in and of itself, can be quite stressful.
Failure to Pay
The IRS tries to monitor and cross-reference all accounts it receives. So even if you don't report income, your client might report it, and then the IRS will notice that you didn't. This results in a significant flag. Additionally, if you fail to pay your taxes at all, the IRS will likely come knocking. Similarly, the IRS may show up for an audit if you don’t pay enough on your estimated taxes.
Businesses are expected to make regular estimated tax payments throughout the year based on their income. If you don’t, you could face penalties and possibly an audit. It's uncommon for businesses to be audited simply because they missed estimated payments, but it can happen. You can learn more about estimated payments at IRS.gov.
Final Thoughts
Getting audited by the IRS can be nerve-racking, but if you know how to avoid the red flags, you significantly reduce that likelihood. Be cautious when filling out your taxes and be meticulous with record keeping. Although you can't completely eliminate your risk of an IRS audit, these precautions can help reduce your chances of getting singled out by the IRS.
If you do get selected for an audit, it's smart to Consult a Legal Pro.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
