Running a successful business is all about preparation and forecasting. Whether you are running a restaurant, tech company, or construction company, staying one step ahead is critical to building a robust and growing operation. Regardless of the type of business you run, paying taxes is an inevitable part of the process and tax audits are generally something you want to avoid.
When it comes to tax preparation for small businesses, accuracy and efficiency are key elements of prosperity and growth. Otherwise, the IRS may come a-knocking. So, as a small business owner, how can you protect yourself and prevent that knock on the door?
Let’s take a closer look at the numbers.
What are the Chances My Small Business Gets Audited?
The chances of an IRS audit are actually pretty low. One percent of taxpayers are audited, but your chances are higher if you run a small business. After the year 2020 and the slowdown of the pandemic, the IRS has announced that they will be ramping up audits of small businesses.
The IRS audited about 140 partnerships tax returns out of the 4 million or so filed in 2018. This comes out to less than .00004%. When it comes to S corporations, the numbers varied some, as 397 returns were audited or .01%.
After a difficult year for all business owners, the IRS will be tightening up in 2021 and making up for lost ground. The good news is that although an audit sounds foreboding, it doesn’t have to be. There are effective strategies your business can implement to avoid raising red flags.
At the same time, implementing these organizational strategies will actually benefit your business in the long run and ensure that you’re not operating on faulty numbers.
Things that may increase your chances of being audited include:
- Surpassing the $1 million dollar threshold. If your business is raking in more than $1 million then congratulations! This is great news, but it also means that the IRS might look at your taxes with a much more careful eye, so incorporating (if you haven’t done so) is a must by this point.
- Failure to report income or earnings.
- Suspicious numbers with your deductions
4 Strategies to Prevent IRS Audits
Like in all matters of life, there are some things that you can control and some things that you cannot. The IRS does conduct some random audits, which fall under the category of things you cannot control. What most business owners can control is raising unnecessary red flags.
#1 Good Recordkeeping is a Must
Recordkeeping is powerful. It gives your business a strong grip on the numbers and gives you an accurate picture of your profits, losses, and cash flow. Maintaining good records is not only beneficial for tax purposes but for the overall strength of the company. Keeping good books will help you avoid mistakes or miscalculations on your taxes and it will give you a solid defense in the event of an audit.
#2 Be Accurate With Deductions
Deductions are there to help business owners thrive, but they are often a pitfall for people that are ill-advised or ill-informed about how to accurately report and categorize these deductions. You should take deductions that you qualify for, but note that the IRS has sophisticated ways of measuring and comparing deductions from other businesses in your tax bracket.
Even a correct but incorrectly itemized deduction can raise suspicion, so clarity and accuracy are essential. In addition, the IRS no longer allows what used to be known as miscellaneous deductions unless you qualify for a specific category.
If a business in your tax bracket generally takes 15 deductions and you file for 178, it might very well raise a red flag. And yet, taking legitimate deductions for your business should not be discouraged on the grounds of fearing an audit. According to some CPAs, home office deductions, business travel, and vehicle mileage are commonly misused deductions and should be used with caution.
#3 Check Your Business Expenses
Changes to deductions and what qualifies as business expenses have also thrown some people off. The Tax Cuts and Jobs Act of 2017, for example, did away with business-related entertainment deductions. So, taking that prospective client out for a round of golf can no longer count as part of the company’s dime. Meals, however, can still qualify for some deductions.
As the IRS clarifies:
“Taxpayers may continue to deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant.”
#4 Watch Your Business Losses
Taxpayers that have not incorporated may be subject to excess business loss limitations. If a business is reporting losses for multiple years, this may be cause for questioning. After all, the IRS knows that every business is in it to make some money, and reporting constant losses can be an indication of something that is being inaccurately reported.
Small Businesses, Audits, and the Quest for Accuracy
In 2012, singer Rihanna was audited by the IRS and ended up suing her accounting firm for what she called bad bookkeeping and gross mismanagement of her finances. The pop singer’s tax forms made headlines when the IRS caught onto the failure of proper documentation and massive losses, which the singer then blamed on her accountant taking exorbitant cuts.
This was a stark lesson to taxpayers across the country. Everyone is subject to audits and how important it is to maintain proper records and hire trusted tax professionals. Her costs associated with defending the tax audit were significant and quite painful for the singer.
The quest for accuracy and proper bookkeeping is very real. Taking steps to minimize the potential for mistakes goes a long way.
As if Ben Franklin didn’t do enough for this great country—pioneer print journalism and help pen the Declaration of Independence, among other things—he also coined the oft-repeated phrase, “An ounce of prevention is worth a pound of cure.”
An ounce of prevention can be fundamental to the longevity of any company.
Get the Tax Resolution and Tax Preparation Help for Your Business
Whether you are a small business or a corporation, keeping accurate records and filing taxes on time with no errors is an inevitable part of your yearly preoccupations. There is no need to panic, however, even when up for an audit. Helping hard-working business owners untangle themselves from debt and IRS audits are part of what we do.
Looking for professional tax guidance for your business? Have you received a letter from the IRS? Don’t drown in hot water. Call us today and learn how we help you emerge successfully.