Why is My Business Being Audited?

The prospect of being audited by the Internal Revenue Service can be stressful for many small business owners. When the IRS demands proof, the burden to provide that evidence falls on the small business owner. He or she must then provide proof of income and expenses, justifying deductions and other items on the tax return.

Common Red Flags

Here are some of the most common red flags that rouse the IRS’s suspicions and could potentially trigger an audit:

  • Filing late: Filing your taxes late year after year could turn the IRS’s attention toward you. As far as the IRS is concerned, it is best to stay below the radar. A late filing is more likely to provoke scrutiny compared to a timely one. Make sure you file your business tax return in a timely manner, even if it means you need to start tax preparation earlier in the year.
  • Net losses: When you report net losses year after year, you are more likely to be audited. If the IRS learns about losses from a sole proprietorship you may get the IRS’s attention because the mingling of funds is common with sole proprietorships.
  • High salaries: Small business owners need to watch their salaries or the salaries they claim to give employees. High owners who are also shareholders could invite unwanted attention from the IRS. It’s a good idea for business owners to become familiar with prevailing wages and salaries in their area of work. The higher the salaries, the greater the chances of an audit.
  • Deductions: It is important that small business owners carefully evaluate and choose their deductions. You need to consider whether meals, travel expenses, gas and other expenses truly qualify as deductions and whether these were business-related. You need to have the documents to back up your claims. One way to avoid unnecessary attention is to go over year-over-year deductions and make sure you are claiming them consistently. IRS guidelines state that business expenses should be “ordinary and necessary.” In other words, the deductions you claim should make sense considering the nature of business.
  • Vehicle use: The IRS also tends to scrutinize tax returns where businesses claim 100 percent use of the vehicle. Be sure you claim a portion of your vehicle use for business purposes. Unless every single trip you make in the vehicle is for business purposes, you cannot claim 100 percent use. Business purposes may include activities such as client meetings, conducting research, etc.
  • Cash transactions: It is best to use a credit or debit card for your business transactions. If your business deals mostly in cash, this might get the attention of the IRS because it is not easy to verify income that is received in cash. A number of businesses such as nail salons deal quite a bit in cash. If you conduct mostly cash transactions, be sure to record your transactions in a detailed and precise manner. This way, you’ll create your own paper trail and will have no problems providing evidence when the IRS asks for it.
  • Digital currency: If you use digital currency such as Bitcoin in your business, the IRS may be more inclined to take a closer look at your transactions. For now, it’s a good idea not to center your business around digital currency unless we all get a better idea about its impact on the economy, particularly on small businesses.

If You Are Being Audited

If you found out that you are getting audited, be sure you maintain a positive attitude. Be meticulous about record keeping and contact an experienced Baltimore tax lawyer to obtain more information about your options.