10 Small Business Red Flags that Could Trigger an IRS Audit

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An IRS audit is a stressful experience for any business owner, but it can be especially daunting for small business owners. IRS audits can be time-consuming, expensive and significantly impact your business's operations.

While some IRS audits are triggered randomly, most are caused by "red flags" that catch the attention of the IRS. Here are 10 things that could trigger an IRS audit.

10 IRS Audit Red Flags for Small Businesses

Round Numbers

The majority of business transactions are made in dollars and cents. This is why round, whole numbers are an immediate red flag for the IRS. Round numbers show that your numbers were rounded up, down, or estimated. This reflects a difference in the amount reported and whatever the actual amount was, which is cause for concern by the IRS.

Misreporting Income

One of the most common things businesses are caught fudging on their taxes is income. Misreporting business income can include reporting a higher-than-average income, rounding up, averaging, or not reporting all income.

Disproportionate Deductions to Your Income

Most small business owners have itemized deductions on their tax reports. However, too many deductions can raise red flags. The IRS dictates that a deduction must be legitimate business expenses. These expenses can be classified as ordinary or necessary.

Ordinary expenses are considered those that are common and accepted in your trade of business. Necessary expenses are considered helpful and appropriate for your trade or business. Necessary expenses must also be ordinary to be eligible for a deduction.

Excessive Expenses

It's normal for your small business's expenses to fluctuate from year to year, but a drastic jump can become a red flag. While you probably have a designated business credit card for everyday expenses, transactions shouldn't be so excessive that they draw attention.

Large Amounts of Cash Transactions

Certain types of businesses rely a lot on cash transactions. Regardless of the nature of your business, the IRS is more likely to audit a company with a large amount of cash transactions. This is because cash is easily underreported. If you own a business that deals with a lot of cash, it's essential to keep a record of all transactions with proper documentation in the event that an audit occurs.

Claiming Business Losses Year After Year

While losses aren't uncommon for small businesses, claiming a loss year after year on your reports can raise suspicion and warrant an IRS audit. If your company indeed does have multiple years of losses, proper and organized documentation can help you show your revenues and expenses and prove that to be the case.

Misclassification of Employees

Many small businesses will accidentally or intentionally misclassify employees as independent contractors. (The IRS defines an independent contractor as someone who controls what works gets done and how it is completed.) If your small business works with a lot of independent contractors, it's crucial that you keep track of and document all the work those contractors do for you.

Net Operating Loss Carrybacks or Carry-Forwards

Business losses can be carried back or carried forward to apply to income for a different year. While this is not uncommon, it can draw attention from the IRS. Again, proper documentation can help your business prove it is legitimate in the event of an IRS audit.

Giving Large Donations to Charity

Small businesses tend to fall under the microscope more than large corporations when it comes to charitable donations, especially large ones. Consider giving smaller, consistent contributions rather than large lump sums to avoid drawing IRS attention to your business.

Consistently Filing Payroll Taxes Late

Aside from the penalties that come with filing late, consistently filing your small business payroll taxes past the due date, or not at all, can almost guarantee an audit by the IRS. This is one of the biggest red flags for the IRS.

The Takeaway

While you can't prevent an audit entirely, it's important to understand practices and procedures that can make your business more susceptible to concerns from the IRS. By adhering to proper reporting measures, you can minimize your business's risk of an audit.

Have questions about IRS audits or your business's unique risks and reporting requirements? Our team of tax experts is here to help. Contact Us.