Small businesses are often the lifeblood of the economy, yet they face unique challenges when it comes to taxes. The complexity of tax law, combined with the diverse nature of small business operations, can lead to errors or omissions that attract the attention of the IRS.
How do small businesses attract the attention of the IRS?
In addition to the errors and omissions noted above, factors that can result in an increased risk of an audit can include:
- Complex Deductions and Credits: Small business owners have access to a variety of deductions and credits. However, improperly claimed deductions or overly aggressive tax strategies can raise red flags.
- Cash Intensive Businesses: The IRS may focus its attention on businesses that operate primarily in cash, such as restaurants and retail, due to the difficulty in tracking and reporting cash transactions.
- Inconsistent Reporting: Discrepancies between reported income and lifestyle or between your filings and associated forms (like 1099s or W-2s from vendors and employees) can prompt an audit.
- High Income or Losses: Reporting high income can increase audit risk simply because there is more tax revenue at stake. Conversely, reporting continuous losses may suggest to the IRS that the business is not a true commercial endeavor.
Whether one of these factors or another triggered the audit, business owners can benefit from a basic understanding of how the process unfolds.
How does the process work?
The first step is selection. The IRS uses various methods to select which taxpayer and business to audit. These can include a random selection, computer screening, or connection to a separate audit. The first two methods make use of new technologies that allow the feds to use software to check for any abnormalities, such as those noted above. Simply put, if your tax return does not fall into the “norm” compared to similar businesses, it may get flagged for an audit.
The IRS is also more likely to take a closer look at tax returns if a business partner or investor is the subject of an audit. As such, if you become aware of this type of issue it is generally wise to use the information as an opportunity to make sure your paperwork is in order.
After the taxing authorities choose to move forward with an audit, they will generally send notification through the mail. This notification will include important information. It is wise to read through carefully, watching specifically for any deadlines. There is the possibility of an extension, but you generally have to follow specific steps to get it.
Can I avoid an audit?
Business owners can implement practices to reduce the risk of an audit. These can include maintaining accuracy, transparency, and organization in your tax affairs. Keeping detailed records of all business transactions, including receipts, invoices, and bank statements, is also wise as this means you have the documentation needed to back up your tax filings. It is also helpful to stay informed about changes in tax laws and how they affect your business. A tax professional experienced in this niche area of tax law can review your plan to better ensure you are taking advantage of applicable deductions and credits without stretching the bounds of the law.
While the prospect of a federal tax audit can be daunting for small business owners, understanding the common triggers, and implementing best practices can greatly reduce the likelihood of an audit. Remember, the key is to be thorough, honest, and proactive in your tax affairs. Should you face an audit, approach it with a calm and organized demeanor, armed with your meticulous records and a knowledgeable tax advisor. The attorneys at Goldburd McCone are experienced in these matters and can provide guidance to better ensure your business interests are protected.