As a business owner, you’re sure worried about plenty of things. The one thing, however, that plagues every businessman is the dreaded audit notification from the IRS. Especially for small to mid-sized companies, audits can surely be scary. Smaller companies can be impacted greatly by audits because:
- These companies generally work on a limited budget. The fact that they owe more tax can result in them having to cut funds from other crucial operations
- Small scale businesses generally don’t have an experienced accounting department to back them up if they are personally held liable
That being said, if you’re in the right, IRS audits can be avoided by taking a few simple steps. First of, for every 100 business, the IRS just audits one every year. So, if you’re careful you can steer clear of getting audited all together.
Why Do Small Businesses Get Audited?
Firstly, it is important to understand that when a business is selected for an audit, it doesn’t always mean that there is a problem. While selected businesses, the IRS uses different methods like:
There are times when businesses are selected purely based on a statistical formula. The departments compared a businesses tax returns against “norms” for similar returns. These “norms” are generated from audits that are statistically valid based on a random sample of returns. These audits are part of the National Research Program that the IRS conducts. The organization uses this program to update return selection information.
Issues With Related Businesses
The IRS could select your business for an audit if they find issues with other taxpayers that are related to you or your business. For example, business partners or investors, who were selected for an audit.
After this initial selection, an experienced auditor will first review your returns. If everything is in order, they will simply accept it. However, if they find something questionable, they will identify issues that forward the return for further assessment to an examining group.
How To Avoid Getting Audited
Don’t Make Math Errors
If the IRS starts investigating you, a simple “it was a mistake”, won’t be enough. You will be fined regardless if the error was intentional or unintentional. So, don’t make mistakes. Check if you’ve written the right numbers and if you’ve added that last zero. Even a simple misplacement of a comma can result in a fine, so make sure you double and triple-check these numbers before filing your returns. If you’re not too sure about your mathematical skills, it is recommended to use a good accounting tool or a tax preparer to help you avoid errors.
Fill All Your Income
Some business owners, who freelance on the side for a little extra cash are tempted to only file returns for their business and keep Form 1099 under wraps. The form 1099 is used to report nonwage income from activities like freelancing, stock, dividends and interest.
That isn’t a good idea.
Regardless if you’ve declared this extra income, the IRS has already received a copy from the business you freelanced for. So, it’s only a matter of time before the agency discovers your omission.
So, if you’re looking to avoid getting audited, make sure you declare all of your income.
Don’t Report Fake Charitable Donations
If you’ve genuinely donated a significant amount towards a charitable trust, then you are eligible for a deduction. However, it’s only common sense to not report false donations. Also, it’s very important to file only those donations you have proper documentation for. So, if you do get audited, you won’t face any trouble.
Don’t File Personal Expenses As Losses On Schedule C
Often, business owners consider filing personal expenses as business expenses. While you might get away doing that for a few smaller expenses, it is important to maintain a balance. If you report too many expenses, the IRS might get suspicious about how you are able to keep your business afloat with so many losses.
File Proper Work Expenses
When it comes to bigger amounts, you have to be sure you are filing only those costs that are eligible as work expenses. A purchase that is ordinary and necessary for your line of work is considered as a work expense. For example, a painter can claim paints and paintbrushes as work expenses, however, a lawyer who enjoys painting cannot do the same. If you’re in doubt while filing an expense, simply ask yourself if the purchase was absolutely necessary to perform work duties.
Be Careful With Home Office Deductions
There are provisions to file for home office deductions. However, you need to be extra careful about what you file. According to IRS, a home office deduction is reserved for only those people who exclusively use part of their home for office or trade work. This basically means that only if you use part of your house for just work, you can file for home office deductions. Occasionally answering your emails or phone calls while resting at home doesn’t count as a home office. It is crucial that you’re honest while reporting your expenses.
It is very possible that the final numbers on your 1040 form and other supporting documents are not going to be in clean 100s. Hence, while calculating, be precise and avoid adding estimations. Moreover, while rounding numbers, round to the nearest dollar and not the nearest hundred. For example, if an expense if $345.25, you can round the number to $346, not $400. If you have too many 100s in your form, the IRS might get suspicious.
Only File Amended Returns When Necessary
When you’re close to the deadline, you might think of filing your returns without checking them, or half of your returns with the intention of filing an amended return later. This isn’t the best idea. If you file an amended return, you are basically telling the IRS that you are not sure of what you’re doing. IRS says, “Filing an amended return does not affect the selection process of the original return. However, amended returns also go through a screening process and the amended return may be selected for audit.”
Hence, filing an amended return is likely to be considered as a red flag by the IRS and could increase the chances of you getting audited. If you honestly forgot to file a document that is likely to cost you thousands of dollars, file the amended return. However, it’s much better to spend an extra hour or so getting the returns right the first time.
Use Electronic Filing
In today’s digital age, filing electronically should ideally be the only way. However, nearly 10% of U.S. taxpayers to this date use paper to file. However, IRS is extra careful about returns filed in paper. According to their website, the error rate for returns filed in paper is a whopping 21%, on the other hand, e-filled returns have an error rate of just one and a half per cent
Hence, to avoid being in the scrutiny of the IRS, it is always recommended to fill in your returns electronically.
Use A Good Accounting Software
If you really want to get your returns right, it is recommended to use good accounting software. You must use this software every day to prevent mistakes from happening before they even occur. Here are the top 5 accounting software that you could consider investing in to get your tax returns just right:
Known as the world’s top ERP solution, using NetSuite you can streamline all your back-office processes, which includes accounting and CRM. Additionally, with this software, you get business intelligence, reporting, and real-time visibility across your organization. Hence, NetSuite is the perfect tool to help all sizes of businesses grow. You can also reduce IT costs while eliminating operational inefficiencies. Due to this, you will be ready with all the numbers and documents while filing your returns, making the entire process seamless. Read our entire review on NetSuite here.
Part of the Zoho family, Zoho books allows you to easily manage the flow of funds in and out of your business. This tool is especially useful while filing your returns as it helps you manage your customers, invoices and keeping your expenses in check. You can also monitor your bank account and transactions while collaborating with your account in real-time. Read our entire review on NetSuite here.
The USP of this tool is that it was created by accountants for accountants. FloQast is equipped with multiple advanced features and tools, which makes it perfect for businesses looking for easy tax filing. However, this tool has extremely advanced features which might not be easy to gauge by everyone. Hence, it is particularly useful for financial account managers, financial officers and accountants. Read our entire review on FloQast here.
Workday Financial Management, or more commonly known as Workday is a cloud-based software that provides companies features that help with financial management. This tool is particularly popular for its greater insights and recommendations for improvements in your financial processes. Companies that run operations globally will find this tool helpful as it helps streamline processes and achieve consistency. It also helps with instilling internal control and auditability, making it perfect for assistance while filing returns. Read our entire review on Workday here.
IBM Cognos is a business intelligence platform is based online. It provides BI software that helps you achieve your company goals. Having the IBM name behind it, it’s no surprise that Cognos is considered one of the top business intelligence tools. The best features provided by this software include an intuitive dashboard, reporting, analytics, scorecard and data integration. Read our entire review on IBM Cognos here.
Microsoft Dynamics 365
The Microsoft Dynamics family consists of multiple tools like enterprise planning (ERP), Dynamics GP and NAV. Microsoft Dynamics 365 Finance & Operations joined that family in 2016 and is the perfect tool to diminish the chances of you getting audited. This tool also gives an added benefit of collaboration, where users can interact with each other and add colleagues to different projects and meetings. Read our entire review on Microsoft Dynamics 365 Cognos here.
What You Should Do If You Get Audited
The first thing to do is not panic. You should be forthcoming and cooperative in any way possible. Provide all relevant paperwork you have and assist the IRS representative whenever required. The IRS has created a guide for you to follow while getting audited as well, which you can refer to here. Just remember, IRS is not out with a personal vendetta against you. And, you have your rights too
What Are Your Rights?
As per Publication 1. Your Rights as a Taxpayer, your rights include:
- Be professionally and courteously treated by IRS employees
- Maintain your privacy and confidentiality regarding tax matters
- IRS has to inform you why they are asking for particular information and what the organization will do if the information is not provided
- You have the right to either represent yourself or get an authorised representative
- In case you disagree with the IRS’s judgement, you have the right to appeal within the IRS and before courts
Audits can be scary if you’re not prepared. After all, they do have the power to cause serious damage to your business that you’ve built with a lot of hard work. Hence, while these pointers above sure will help you to prepare for an actual audit, we recommend conducting internal audits regularly. Conducting these internal audits will give you peace of mind as it ensures that you are following ethical business practices. Moreover, if you’re conducting business globally, it is crucial for you to conduct internal audits due to the introduction of GDPR. Besides helping you prepare for an actual audit in advance, these internal audits will also help you take proactive business decisions rather than taking expensive shortcuts at the last minute, which will likely cause more damage than good.
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Note: This article is written with the intention to inform our readers about business concerns in the United States. The article in no way intends to provide financial advice or promote a particular course of action. We recommend for advice on specific situations that any business owner is facing, they should consult the accountant or professional financial consultant.