Few things can frighten a small business owner more than hearing that your company books will soon be audited. You may be haunted by the idea that “you are guilty until you have proven yourself innocent” or in believing you must keep every paper you ever produced to provide answers to the government’s questions during an audit. No matter how carefully you prepare and file your taxes, many red-flag issues may cause the agency to target you for the dreaded review. Here are seven of those reasons.
When the auditor goes through your business records, they often look for excessive deductions your business may have taken in travel, meals, or entertainment. The laws change each year, so it is important to stay up to date on tax modifications, such as the removal of most entertainment deductions in 2017. This will prevent problems with tax filings using old information.
Business trends can be wild as consumers move from one popular idea to the next. So, when your business has an erratic income pattern over several years, the anomaly can set off red alerts with the government’s auditors. Rather than waiting to be contacted, fill out a disclosure statement that explains the reason for the discrepancy in your tax filing. Being proactive can prevent a lengthy auditing experience.
When excessive salaries to shareholders are reported that are unreasonably high for the business, and those shareholders are also employees, the agency will automatically audit the company. If there is dual compensation in your company, be prepared to justify it with the auditors.
Businesses that regularly deal in cash purchases are audited more often because of the possibility of under-reporting of available and taxable income. If you run a cash business, it is almost impossible to verify all the profit the company received. However, making a daily journal of expenses and receipts can help – as can keeping all receipts generated each day.
If your company experiences net business losses for several years, the net loss reporting will red flag the auditing system at the government agency. This is especially true if you are a sole proprietor in a relatively new business because many owners struggle with intermingling business and personal monies as they attempt to save a struggling company.
Although it may be true, claiming a company vehicle is used exclusively for business is a problem. Understanding that personal errands sometimes occur when out on a business run is the issue. To prove the 100% rule, keep written details of business runs and mileage logs.
An actual government employee looks carefully at amended filings, and some amended returns even go through a careful screening process to see what the amendments are, how many items were corrected, and how the amendment benefited the company. If a justifiable mistake appears, the auditor will likely ignore the filing, but if it is a pattern of missing a deadline with no justification, the auditors will notice.
If you own a small business, your chances of getting audited are higher than if you incorporate it. Although the reasons for this phenomenon are still being studied, some researchers believe it is because corporations are allowed more deductions than small businesses, and the big organizations rely on tax consultants more often than small business owners.
You can protect your small business from the possibility of an audit by taking proactive steps. Complete and thorough record-keeping such as cash income logs and detailed deduction reports are essential. Also, make sure your records are not post-dated from memory. The auditors are experienced in seeing through all types of possible problems in the documentation.