Late last year, the Internal Revenue Service (IRS) said it planned to increase small business audits by 50% in 2021. That came at a time when most small businesses were reeling from the effects of the pandemic.
While audits are never welcome, and it was the last thing business owners wanted to hear, the good news is that implementing sound strategies can eliminate mistakes that lead to unwanted attention from the IRS.
Solid business practices that can help you avoid an audit
Here are four actions to take to keep you from having a tense meeting with an auditor:
Good record-keeping: Keeping accurate records are a business’s best defense against an audit. Staying on top of this provides a two-fold approach:
- Comprehensive documentation prevents mistakes over reporting revenue (gross receipts) and allowable tax deductions for expenses
- Proof and justification of deductions and income for the IRS are provided through essential small business tax documents
Having a reliable bookkeeping system in place can save you from enormous headaches later, whether it’s a third-party tax professional, an employee or accounting software.
Accurate deductions: Small business owners understandably want to deduct as many expenses as possible. However, auditors look for red flags, such as an unusual deduction, even if it’s valid. Make sure all deductions are accurate and that you can explain every single one.
Estimated tax payments: Late payments often trigger IRS officials to take a deeper look at a business. All sole proprietorships, S corporation shareholders or partners must make estimated payments if they owe $1,000 or more when filing their taxes. Corporations should make an estimated payment if they expect revenue of at least $500.
Independent contractors: While these individuals can play an essential role in helping small businesses grow, having a high ratio of independent contractors to full-time workers is another audit trigger as some companies use them to avoid payroll taxes. Make sure they are classified correctly, meaning you can control the outcome of their work, but not how they get the job done.
Study how tax rules have changed
Last year saw a multitude of changes to the U.S. tax code. Some of them are related to pandemic relief programs, such as the Cares Act, the Families First Coronavirus Response Act and federal funding passed last December.
Many of these changes overlap. For example, businesses receiving PPP loans are not eligible to claim employee retention tax credits. But at the same time, they could defer Social Security taxes. Navigating these changes can be tricky, but ensuring that your returns are accurate can help you avoid an audit.