15 Aug Some tips on how to avoid tax audit for small business owners
By Atty. Crispin Caday Lozano
Only a small fraction of businesses get audited. When an audit takes place, there is a letter from the IRS asking for more documentation to clear up any discrepancy. The taxpayers should be prepared for this eventuality and here are some tips on how to avoid an audit and how to deal with one if it does happen.
- Check your numbers. If you receive a 1099 for income received from third parties, they also report the information to the IRS. If there is a discrepancy, the IRS will issue you a notice or could audit your tax return. Also, your tax return can attract attention if the numbers don’t add up, so it is a good practice to double check the information and check the math. Consider hiring an accountant prepare your tax return or use software that will do the math for you.
- Don’t pay overly high salaries to employees who are shareholders. If you have a C corporation and pay your executives a high salary to minimize corporate e profits to lower your taxes, these unusually high salaries may open your tax returns to scrutiny. Find out a reasonable salary range for your industry and do not exceed it.
- Do not report a loss every year. If you report a net loss more than two out of five years, you are likely a candidate for a tax audit. If the IRS determine than your business is a hobby, chances are your business expenses will be disallowed.
- Keep good records and report income and expenses accurately. Audit is minimized if you keep all your business income and expenses in a bank account and retain your business receipts. Not only will this easier to prepare your tax returns, it will also support your tax return in case of an audit.
- Be careful of independent contractors. An unusually high ratio of independent contractors to employees will be a red flag for audit. The IRS has clear guidelines on who can be an independent contractor and who must be classified as an employee. Make sure the rules are followed and when in doubt, consult a tax lawyer or accountant for business advice.
- Claim a home office deduction if you can legitimately take the deduction. Home office is usually red flags for tax audits. Currently, one can take a home office deduction if your space legitimately qualifies. For most taxpayers, the home office must be a separate room that is used exclusively for business, thus a desk in the corner of the living room will not work. A home office deduction can still create an audit risk if you have large expenses for maintenance or utilities or you claim a home office and rent an office space somewhere else.
- Pay your estimated small business taxes. If you expect to owe at least $500 in taxes for your business entity at the end of the year, you should be making quarterly estimated tax payments. If you fail to make these payments can result in penalties and can put you at greater risk for an audit.
When you keep good records and are honest on your tax return, you should not fear a tax audit. But when you are not sure of the income you should report and the deductions you are allowed to take, it is always a good idea to seek tax advice from a tax attorney, a CPA or an accredited accountant. Should you have any tax questions or need tax advice, you should consult with independent tax consultants or tax professionals.
Note: This is not a legal advice