An audit can be stressful for any business owner, and even more so for those that bend the rules or do not keep organized business books. Today, we address 5 common factors the IRS considers when auditing small businesses. We also always recommend working with an accountant to help you navigate your audit!
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1. Does your business handle primarily cash?
If so, ensure you have a consistent and organized way to record transactions if they occur. Ensure you do not round and double check all of your calculations. Even better, work with a CPA to handle your bookkeeping so you can be sure your books are correct and organized. Because cash is more difficult to verify transactions with, it is extra important you establish a paper trail especially when making business expense purchases!
2. Are you business expending correctly?
Be sure that business expenses you right off are just that: business expenses. If you use your car both for business and personally, be sure to track your mileage using an app or a detailed record. Also be careful when writing off personal expenses as business expenses. If an auditor sees a large expense deducted that is actually a personal expense, they may add a penalty fee on top of disallowing the expense. Be sure to also track all meals and travel expenses for your business. If you bring family on a business trip, for example, be sure to separate their costs from your when deducting your trip's expenses.
3. Are you reporting all transactions with receipts?
If you fail to report a significant amount of business income, this appears as a major red flag to an auditor. In this case, it is strongly recommended you hire a tax professional to guide you through your audit. If there was simply a transaction mistake, you may be able to just pay the interest and 20% penalty in lieu of an investigation. If you have accounts offshore, be sure to report these, as well! Additionally, if you have income from foreign countries, you be eligible for a foreign earned income tax exclusion. Consult your tax professional to see if you qualify!
4. Do you hire independent contractors instead of employees?
Because the rules are different regarding independent contractors versus employees, many times a small business will choose to hire contractors to save taxes. In fact, approximately 30%of companies misclassify employees according to the Labor department. However, this is regarded as a serious issue to the IRS because it costs the U.S. government tax dollars that would otherwise be paid if taxes were automatically withheld from their paychecks. Not sure if your contractors are employees or vice versa? Here's a link to a great questionnaire to help you decide!
5. Are you paying the right amount of payroll taxes and making the proper tax payments?
Employment taxes are routinely part of every small business audit. Be sure to record all net losses and gains year-over-year. This issue often returns back to if you misclassify employees versus independent contractors. Once again, the best way to stay clear of any mishaps is to keep detailed records of your business finances, or better yet, work with an accounting firm to let the professionals handle the nitty gritty of your finances.
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