As a growing business, you’re always looking for ways to put your company front and center. One area you don’t want to draw more attention to, however, is your tax return. Unlike with individual tax returns, business returns are more prone to IRS scrutiny.
There are a handful of missteps that can tip off the IRS and lead to an audit. Here’s where you need to be careful:
TIP: Even if the reason is legitimate, such as greater demand for your products or services, be aware that the IRS will expect your return to show additional expenses that were necessary to support that spike.
TIP: Mathematical errors, such as getting the number wrong when you subtract your expenses from your business income, will most likely be noticed. The same goes for data entry errors. Double check that the numbers you enter on your tax return match those from your source documents, and be certain you don’t leave parts of your schedules or returns blank. Filing electronically can help cut down on the types of errors that happen with old-fashioned paper filing.
TIP: The IRS will be suspicious if you claim a large amount of deductions relative to your income – or if the deductions aren’t typical for your type or size of business. Excessive meal, travel and entertainment expenses often set off alarms, especially if your industry doesn’t demand this type of activity. Also, don’t round off numbers. If you’ve kept careful records throughout the year, you should be able to provide the exact amounts for “ordinary and necessary” business expenses.
TIP: The IRS looks closely at businesses that rely more heavily on independent c m ,ontractors than employees, as this can be a tactic for avoiding payroll taxes. See Independent Contractor vs. Employee for guidance on properly classifying independent contractors and issuing 1099s.
TIP: Be aware that the IRS will examine your deductions more carefully if your business is losing money. You may be singled out, too, if you show a loss year after year. Businesses must earn a profit three out of every five years. Otherwise, the IRS considers your business a hobby, and no losses may be taken.
Although no business wants to receive a notice of a tax audit, the situation isn’t cause for panic. As long as you can prove to the IRS your initial return was complete and correct, you’ll be fine. In the case of errors or purposeful misreportings, however, you’ll most likely have to pay the recalculated amount and interest penalties.