Common Reasons Small Businesses Get Audited
Every small business owner knows that the Internal Revenue Service (IRS) has the power to audit your taxes. But do you understand why they might choose to audit your business?
Audits can be time-consuming and expensive, so it’s important to know what triggers an audit to avoid them.
Not understanding how or why audits happen could leave you feeling helpless if one occurs.
In this blog post, we’ll discuss some common reasons small businesses get audited and provide tips on protecting yourself from being targeted by an audit. We’ll also explain what happens during an IRS audit and advise on how best to respond if one does occur.
Misreporting of Income
The most common way small business owners come under auditor scrutiny is by misstating their income.
To avoid an audit, it is essential to accurately report all forms of income — including cash payments — on your tax returns.
It’s also important to be mindful of any deductions or credits you claim so that the amount reported on your return matches up with the information provided by third-party sources such as banks or customers.
If there are discrepancies between what you report and what other sources report to the IRS about you, your return may be flagged for review or an audit.
Large Amounts of Cash Transactions
Another red flag for an audit is when a small business has large amounts of cash transactions throughout the year.
This could signal that the business is not properly keeping track of its financial records, leading to inaccurate reporting or even tax fraud.
To avoid this situation, it’s crucial to ensure that all cash transactions are properly documented — including invoices and receipts — to demonstrate where every penny came from and went regarding sales and expenses.
Claiming Losses for Too Many Years
Another reason why small businesses get audited is due to claiming losses for too many years in a row without any profit being made.
If your business has been consistently losing money over several years but still operating with no end in sight, this could raise a red flag with the IRS since it could signal tax fraud (i.e., running a “business” solely as a vehicle to generate tax losses).
Ensuring Sufficient Documentation for Claiming Losses
If you are legitimately operating a business running at a loss, there are ways to help minimize your audit risk.
Maintaining adequate records and documentation for any losses claimed on the tax return is essential. This includes having a reliable bookkeeping system so expenses can be adequately tracked and categorized.
Additionally, keep detailed bank statements and proof of payments throughout the year. These documents will come in handy if an IRS auditor comes knocking on your door.
Ensuring you have sufficient documentation backing up your expenses should help prove that your business isn’t just another fraudulent scheme designed to avoid paying taxes. These documents can also help you justify your income and many cash transactions.
Misclassification of Employees
This can happen when employers classify their workers as independent contractors instead of employees.
The IRS looks at several criteria to determine whether someone should be classified as an employee or a contractor.
If your business has misclassified workers as contractors when they should be considered employees, you’re at risk for an audit.
To avoid this, you need to ensure that all your workers are correctly classified so you can comply with applicable laws and regulations.
How To Properly Classify Your Employees
To correctly classify your workers, you need to understand the three criteria the IRS uses to determine whether someone is an employee or a contractor:
Behavioral control: Does the business control how and when workers perform their jobs?
Financial control: Does the business provide direction on how much and when the worker gets paid?
Relationship between parties: Are there written agreements indicating who is responsible for taxes, benefits, and more?
If most of these factors point to work being done as an employee rather than a contractor, you should treat your workers as such and ensure their taxes are withheld accordingly.
Not Paying Quarterly Estimated Taxes
Finally, businesses get audited when they fail to pay their quarterly estimated taxes on time.
Quarterly estimated taxes are due four times a year (January 15, April 15, June 15, and September 15) based on the income the business generates during that quarter.
If these payments are not made on time or in full, there will be significant penalties from both federal and state tax authorities which may trigger an audit. The best way to avoid penalties and an audit is to ensure that your quarterly estimated taxes are paid on time.
Here’s a quick guide on how to do this:
Calculate your estimated tax liability: Calculate how much you owe concerning the income earned during the quarter. This amount will be divided into four and should be paid each quarter.
Pay your dues: Once you have calculated what you owe each quarter, pay those dues on time using IRS-approved payment methods such as checks, credit cards, or electronic funds transfers (EFT).
File Form 1040-ES: In addition to paying your quarterly estimated taxes, also file Form 1040-ES. This form will help you to track your quarterly tax payments and keep a record of all the taxes that have been paid.
Make necessary adjustments: If your actual taxes are more or less than what was estimated, make necessary adjustments in the next quarter by either paying additional taxes or claiming a refund.
Need Help? Contact The Core Group Today
No one likes being audited, but it’s essential to understand why audits can happen.
By following the tips above, you’ll be able to reduce your chances of being audited. Even if it happens, you’ll have sufficient documentation to prove your business complies with all applicable laws.
If you need help understanding tax audits or assistance in any other accounting matters, contact The Core Group today to get the help you need. Our highly experienced professionals will be more than happy to assist you in any way possible.
Reach out now and let us handle your taxes so you can focus on running your business!