6 THINGS THAT COULD TRIGGER AN IRS AUDIT ON YOUR BUSINESS

IRS audits are, at best, a nuisance for your business. And though audits aren’t always avoidable, some scenarios can trigger one more readily. Today, we’ll look at how to potentially avoid some of these situations and what to do if you can’t. Here’s the first potential trigger.

High deduction-to-income ratios

It isn’t uncommon to have a high deduction-to-income ratio, especially when the business is new. For example, if your startup only posts $100,000 of income but has a payroll deduction of $200,000, that may not raise a red flag for IRS auditors in the first year or two. However, if that type of imbalance persists, they may become suspicious. If this keeps happening for some legitimate reason, consult regularly with a CPA to be more prepared for a potential IRS inquiry.

High income on sole proprietorship

In 2018, the IRS Data Book reported an audit rate of 1.4% for Schedule C filers reporting between $200,000 and $1 million in gross receipts. That number jumped to 3.23% for those reporting over $1 million. That’s because the IRS is concerned the business owner is trying to write off personal expenses as business ones.

There are two things you can do to help avoid an audit in this scenario. First, be accurate in your tax filings. Good records may not hold off an audit, but they can make one easier if it occurs. Second, know the rules of tax write-offs. This can be tough to keep up with as a small business owner, so having a CPA to consult with is a big help.

S-Corp shareholder-employees with low or no salary

S-Corp setups have inherent tax advantages. One of the biggest is avoiding the 15.3% self-employment tax. But the IRS requires S-Corp shareholders working as employees to receive compensation that is “reasonable” (their words, not ours). So, an audit may be coming if an S-Corp owner reports no salary or one the IRS deems too low.

Preparation is the key to this situation. If it occurs, it’s best to have a CPA familiar with the situation to offer advice and help you prepare for any inquiries from the IRS.

Home office deduction

The IRS rules on home office deductions are fairly involved and often misunderstood. But there are two big things to know about. First, you can only deduct an area exclusively set aside for business. So that desk in the bedroom doesn’t count as an office in Uncle Sam’s eyes. Also, the office must “generally be the taxpayer’s principal place of business.” Throwing a laptop in a spare bedroom and sending one business e-mail a week from it probably won’t impress an auditor.

Those simple examples aside, awareness and knowledge are the tools your need here. So, take some time to study the rules linked above. Of course, there will always be gray areas, so consult with a CPA if there is any doubt about this deduction.

Having a large number of independent contractors

There’s nothing illegal about relying on independent contractors. But the IRS wants to ensure you aren’t mislabeling employees to avoid payroll taxes. A quick look at IRS Publication 5520 will help you understand the difference. It’s a great infographic with links to other helpful publications.

Running a cash-heavy business

There’s no good way for some legitimate businesses to avoid operating on a mostly-cash basis. But cash is hard for the IRS to track, so they tend to look closely at cash-heavy enterprises. Keeping thorough records of all cash transactions is a must if you run a business like this. And for cash payments over $10,000, be sure to file an IRS Form 8300.

The Bottom Line

Sometimes, avoiding things that might trigger an IRS audit is difficult. But keeping accurate records and having a CPA as a trusted advisor will make life easier if you do have to go through one.