Audit Triggers for Small Businesses

With the IRS gaining additional funding, the agency is expected to increase its focus on audits. Although only 1% to 2% of small businesses are audited annually, it’s important to avoid common practices that might raise red flags. Here’s a guide to help you minimize your risks.

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December 17, 2024

Common IRS Audit Red Flags for Small Businesses

Underreported Income

The IRS receives copies of 1099 forms, including the 1099-K for 2024, which covers income over $600 from platforms like PayPal and Venmo. If you fail to report income from these sources, the IRS can easily spot discrepancies. This could lead to an audit, as the IRS already has access to this data.

Heavy Cash Usage

Using large amounts of cash might look suspicious. Since cash transactions often lack sufficient documentation, the IRS could question your income reporting. If your declared income is low but you handle significant cash transactions, you might attract attention.

Claiming Significant Expenses

If your expenses are significantly higher than in previous years or compared to similar businesses in your industry, the IRS may investigate further. Ensure that all expenses are well-documented and justified. For instance, keeping detailed receipts or records can provide the evidence you need in case of an audit.

Insufficient S Corporation Shareholder Wage Income

S Corporation shareholders must pay themselves a reasonable salary. Failing to do so might look like an attempt to avoid self-employment taxes. The IRS could flag this practice, especially if your compensation appears too low. Always ensure you pay yourself a fair salary in line with industry standards.

Relying on Rounded Numbers

The IRS tends to question rounded numbers. Such figures may appear inaccurate or like estimates. For this reason, always keep precise records for all expenses and income to avoid suspicion.

Additional Practices That Could Trigger IRS Attention

Employee Misclassification

Misclassifying workers as independent contractors when they should be employees can trigger an audit. Employers might attempt this to avoid paying payroll taxes and providing benefits. However, it’s critical to properly classify your workers. Keep detailed records to justify these classifications.

Consecutive Years of Losses

While small businesses may experience losses, claiming consecutive years of losses can raise concerns. If this pattern continues, the IRS might question your business activities. Therefore, make sure to keep accurate records to justify these losses and show they are legitimate.

Minimize IRS Audit Risks

To minimize your risk of an IRS audit, make sure your business maintains proper documentation, reports income accurately, and avoids suspicious practices. If you have any doubts about your taxes, contact DuPage Tax Solutions for expert assistance. We can guide you to ensure compliance and peace of mind.

References

“Audit Techniques Guides (ATGs).” Internal Revenue Service, www.irs.gov/businesses/small-businesses-self-employed/audit-techniques-guides-atgs