By: Docstoc
Articles
Thursday, February 13, 2014
There are plenty of common audit
triggers that business owners know to avoid. Never mix your business and
personal finances. Don’t deduct things without receipts. Most of these
preventative measures come down to common sense.
However, every year countless
businesses get hit with an audit they never saw coming, and it ends up wasting
their precious time and money. Where did they go wrong? Here are 10
little-known audit triggers that every business should know (and some
suggestions on how to avoid them):
1.
Having more contractors than employees.
It’s tempting to classify your
workers as contractors rather than employees, since it can alleviate your
business from the stress of handling payroll taxes. The IRS is on the lookout
for businesses that mislabel workers to cut corners, and it is especially
suspicious of businesses that have a lot of contractors. Make sure that your
company is properly classifying its workers here.
2.
Claiming “miscellaneous” deductions.
If you want to avoid an audit, do
your best to avoid claiming too many deductions categorized as
"miscellaneous" or “other” under Schedule A. Instead, itemize your expenses in the
most relevant categories in Schedule C, and if you have a more unique
deduction, do your best to clearly explain what it is.
3.
Extremely high executive compensation.
Because high salaries reduce a
company’s overall income (and therefore their overall tax liability), the IRS
takes a close look at high-income earners and shareholder-employees in C
corporations. Learn more about how to prevent scrutiny for “unreasonable
compensation” here.
4.
An inconsistent social media profile.
Yes, you read that correctly. If
auditors are suspicious of unusually high deductions, they will seek out any
available information to corroborate your tax claims; sometimes, this involves
looking at your social media activity. So if you are planning to
deduct business trip expenses on your taxes, be careful about tweeting photos
that make it look like a party vacation rather than a professional excursion.
5.
Family members on your payroll.
It’s certainly not uncommon to hire
a family member, but the IRS will want to make sure you’re not simply trying to
get more money out of the business or give family members gifts with less tax
liability. If you have any family members working for you, make sure they are
actually working the hours specified and aren’t suspiciously under-qualified or
inactive in their position.
6.
Reporting your net income rather than gross revenue.
A lot of business owners
unintentionally report their net income on Schedule C rather than their gross
income from sales. For example, if someone purchases your product on Amazon,
you may receive an Amazon Payment with the processing fee already taken out.
You should report your gross income (the total amount before the fee was taken
out) in Part I, and then report the processing fee as an expense in Part II.
7.
Excessive home office deductions.
Although the IRS has slightly loosened
its grip on home office deductions, they are still widely
considered a red flag if you are claiming a hefty deduction in comparison to
your business income. Be especially wary if you are claiming:
- Both a home office and a rented office space
- More than 50% of your home
- A lot of expenses for home maintenance and utilities
This one should go without saying,
but failing to meet any deadlines set by the IRS makes you appear inconsistent
and increases your likelihood of an audit. This doesn’t only apply to your
annual tax returns; other deadlines, such as your quarterly estimated tax payments, are just as important.
8.
Missing any tax-related deadlines.
This one should go without saying,
but failing to meet any deadlines set by the IRS makes you appear inconsistent
and increases your likelihood of an audit. This doesn’t only apply to your
annual tax returns; other deadlines, such as your quarterly estimated tax payments, are just as important.
9.
Using the wrong accounting method.
There are two basic accounting
methods, cash accounting and accrual accounting. Most companies can use the
accrual method, but not all companies should use the cash accounting method. Learn the difference between the two, and make
sure that you are using the correct system before filing.
10.
Self-employed travel and entertainment.
Being self-employed or a sole proprietor makes you a bigger target for the
IRS right off the bat. You will need to meet rigid substantiation rules in
order to deduct meals, flights, hotels and other travel expenses. Especially
when deducting entertainment and food expenses, keeping a receipt is not always
enough; keep detailed records of the location, who was in attendance and the
purpose of the gathering.
The
Final Step
If you really want to avoid being
flagged by the IRS, one of the best things you can do is e-file. Using online
software significantly reduces your chance of an audit, since all of your
numbers (and errors) will be checked by the system before submitting. Tax
software like TurboTax can point out potential
red flags and help predict your likelihood for an audit, so you can clear up
any issues before filing. E-filing also reduces the risk of being flagged for
illegible or unclear handwriting.