Small Business Tax Audit Triggers

Being audited by the IRS can be a terrible and expensive ordeal. True, the odds of it happening are very slim, but if it does happen, it means time and money—potentially a lot of money—and possible criminal prosecution. The problem for the small business owner is that the IRS has a special interest in auditing small firms, so much so that Congress is starting to take notice. At a recent hearing of the House Small Business Committee, Committee Chair Nydia Velázquez (D-NY), questioning Internal Revenue Service Commissioner Douglas Shulman about the rise in IRS small-business audits said, “I find the IRS’s recent shift in auditing attention from large companies to small businesses troubling. Our nation’s entrepreneurs are having a difficult enough time without the IRS stacking the deck against them.” 

“Like all taxpayers, entrepreneurs just want straightforward answers to questions and a clear-cut process to file their taxes,” said Velázquez. “We need our entrepreneurs to revitalize our economy, and the IRS can help by ensuring these small companies start benefiting from small-business tax relief under the recovery act.” 

Here is Mr. Shulman’s opening statement, discussing what the IRS is doing for small business:

Some of the reasons for the IRS interest is that small businesses are often used to hide money, home business owners sometimes play fast and loose with their deductions, personal and business money becomes commingled. Sometimes things are done on purpose. If you run a cash-only business, it is tempting to underreport your income, especially in these hard economic times. Sometimes its merely a mistake you made in estimating how much of your home is used solely for business. Sometimes it is a matter of hitting an income level that triggers an audit. If you make a million dollars, for example, your chances of an audit rise from less than 1% to 5.6%. 

There are plenty of reasons for the IRS to audit your small business, and your best defense is to eliminate those reasons as best you can. Here is a list of audit triggers compiled by business writer Rhonda Abrams for USA Today. 

Audit Triggers:

1. Hiding income
2. Making more than a million dollars
3. Mixing personal and business expenses
4. Entertaining
5. Losing money more than three out of five years
6. File a Schedule C return
7. Taking the home office deduction
8. Using your car for business 

One thing that Rhonda suggests is that you file at the last minute. “Since fewer returns are filed early,” she writes, “BDO Seidman claims you'll have a lower chance of being audited if you file closer to deadline. So thumbs up on your procrastination!”

That may be right, but as always, it is important to consult your tax professional before taking action. You will be glad you did.