Since last year, the IRS has increased audits of small firms. Here’s everything you need to know to avoid a tax audit for your small company.
What you’ll discover:
Tax Audit Avoidance Tips
Audits and pandemic tax relief
Get assistance with your small company taxes.
Getting notification that you are being audited may be quite stressful, particularly for a small firm. Since you must devote all of your time and attention to operating your business, a tax audit may be extremely difficult.
Fortunately, tax audits are uncommon. Just approximately 2.5% of all small company owners will be required to undergo an audit. Nonetheless, the odds of getting audited this year or in the next years are increasing. President Biden has often voiced his support for raising the amount of IRS audits. The President’s Build Back Better Plan calls for a $80 billion IRS expansion to increase the number of audited returns each year. While the Build Back Better Plan has not yet been enacted into law, IRS audit reform is expected to occur shortly.
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Tax Audit Avoidance Tips
Although the chance of getting audited is still quite low, no one enjoys being audited. You may reduce your odds of having to deal with the IRS even more by taking some extra procedures before completing your return. These are seven ways to avoid an audit.
1. Check all of your paperwork twice.
Minor mistakes trigger red flags with the IRS. For example, if you get a Form 1099, be certain that the numbers on your return match the numbers on the 1099. Documents such as 1099s are also given to the IRS, and if they do not match exactly, it may necessitate a deeper examination of your whole return.
Arithmetic or other flaws may also raise worry. Some of these more prevalent red flags may be avoided by using software or consulting a tax specialist.
2. Do not disclose a loss.
Although you undoubtedly want to deduct all of your small company costs, posting losses year after year will draw the IRS’s notice. If you record losses in two of the past five years, you are more likely to be audited.
The IRS wants to ensure that your small company losses are the product of legitimate business operations, rather than an attempt to avoid paying taxes in other areas. If you consistently incur losses, the IRS may define your firm as a hobby rather than a profitable operation.
3. Maintain adequate shareholder compensation.
If you pay wages to your shareholders, they must be fair. Paying executives large pay can help you avoid corporation taxes, but you may go too far.
Determine what an acceptable compensation for an executive in your business is and use that figure as a starting point. Adhere to reasonable compensation for the work at hand, and you’ll be less likely to attract the IRS’s notice.
4. Correctly classify independent contractors and employees.
If you have a large proportion of independent contractors versus employees, the IRS may have an issue. Some small company owners purposefully try to categorize all of their employees as independent contractors in order to avoid paying taxes and benefits for them. Examine IRS instructions on worker classification to avoid unwittingly misclassifying your staff. Correctly classifying employees can help you avoid a tax audit.
5. Submit your work on time.
Submitting late raises the possibility of an audit for your small company. When you file late, your return is not processed with the rest of the returns. This gives the IRS extra time to analyze your return for any problems. You will also avoid having to pay interest and late penalties if you file early or on time.
6. Avoid using rounded or approximated numbers.
Rounded figures, such as $500 instead of $523, might indicate that you are estimating how much you spent or earned—and that you may be giving incorrect information. Round numbers may indicate laziness, inability to report correctly due to a lack of records, or dishonesty. You do not want to send any of those communications to the IRS. If you spend $13 on ink, note that you did so.
7. Accurately report deductions.
The IRS will scrutinize returns that accept certain deductions. Since these deductions are the most often abused, they need a more thorough examination in certain cases.
Deduction for home office. You may claim a home office deduction if you utilize your home for business purposes. But, if that sum seems to be excessive for your sort of company or the size of your property, you may have an issue.
Meals and transportation. You may deduct 50% of your business meals and travel expenditures. Keep an eye out for this sort of spending. If it becomes too much for your sort of company and income bracket, the IRS may want to investigate.
Donations to charities. Huge charitable contributions raise a significant red flag for the IRS. Although they are obviously beneficial to the charity, they might also indicate that the firm is merely aiming to avoid paying taxes in certain cases.
Audits and pandemic tax relief
Small company owners that took out PPP loans or got EIDL subsidies are not more likely to be audited by the IRS than other firms, although they may be audited by the SBA. The SBA has the authority to examine PPP loans of any size. The government has said that it intends to examine all loans worth more than $2 million once lenders submit the borrower’s debt forgiveness application. Similarly, as part of the application process, firms who obtained EIDL loans committed to utilize the money for permitted purposes and disclose documents to the SBA for audit purposes upon request.
If your PPP or EIDL loan is audited, the auditor will look at:
Your company’s loan eligibility at the moment you applied for it.
If the loan money was utilized for CARES Act-allowed objectives.
Whether or not debt forgiveness was accurately computed.
Payroll reports will very certainly be a major source of evidence indicating that the funds were required and that the loan profits were handled responsibly. All PPP/EIDL loan paperwork should be kept in your company records for at least six years after the loan was canceled or paid in full.
Lastly, any firm that claims the Employee Retention Credit or receives other Federal pandemic-related tax assistance may be audited. If your company is audited, in addition to the advice above, be prepared to establish that the company was entitled to the tax relief requested.
Get assistance with your small company taxes.
There has never been a better moment to double-check and re-check your tax return, particularly with the IRS’s enhanced scrutiny of small company files. In case of an SBA audit, this is also a good opportunity to compile your papers demonstrating how PPP or EIDL loans were utilised.