The IRS keeps the exact criteria it uses for auditing select business tax returns a secret. The audit process includes some random selection, but there are certain triggers that are known to make an audit more likely. While an audit shouldn't be a concern if you file your taxes accurately, understanding the common audit triggers can help you to better prepare your taxes and ensure you have adequate documentation in the event you are audited.
The IRS uses a computerized process to match all of the tax forms issued to your business with your tax return. If you omit a form or if the numbers don't match, your tax return will be selected for human review. If your tax return intentionally differs from any of your tax forms, including a clear explanation with your tax return may be enough to satisfy the reviewer without a formal audit being initiated.
If your company has been audited in the past or a business owner is undergoing an audit, the chances you will be audited increase dramatically. This is especially true if the IRS has found discrepancies in previous audits.
High Income or Assets
The IRS audits businesses with higher income or assets more frequently under the theory that the potential tax dollars that can be collected are much higher. The IRS Data Book shows that businesses with balance sheets reporting assets less than $250,000 were audited 0.9 percent of the time while those with assets between $5 million and $10 million were audited at roughly double that rate. Corporations with balance sheets of greater than $20 billion were audited 84 percent of the time.
Most businesses set out to make a profit, so the IRS takes notice when businesses repeatedly show a loss. The goal isn't to punish you for having a bad year or not being able to adapt to economic changes. The IRS is looking for businesses that take excessive non-business related deductions, such as the owners expensing personal travel. Be sure to keep records of all expenses for at least three years.
Large Business Entertainment Deductions
Business entertainment deductions are also carefully scrutinized due to attempted claims for personal travel or parties. If you regularly entertain clients to try to gain sales, you'll need more than just meal receipts. Keep a record of each event, regardless of whether it was a one-on-one lunch or a large gathering, that details who was there and what the business purpose was.
The IRS Data Book also shows that the IRS examines a little over one percent of the returns filed by tax-exempt organizations. The most common reason for these examinations is to ensure that the organization continues to meet the criteria for tax exemption. The IRS may also conduct an audit when it notices unusual patterns on individual tax returns related to deductions for donations to the organization.
Excessive Contributions to Charity
Large charitable contributions are often a cause for an audit. With many businesses now having a social or charitable component to their business model, the IRS may begin to look more closely at whether these tax write-offs are valid. As a general rule, if your business donates a percentage of sales, the organization you are donating to should not provide any kind of benefit to your directors, officers or employees.
Of course, with random selection, you can't always avoid an audit, and you shouldn't avoid taking legitimate deductions because you're afraid of an audit. If you keep accurate records to back your tax return, an audit should be resolved quickly in your favor. Online bookkeeping services can help make sure all of your documents are in order.