Business tax returns have a higher rate of audit than individual returns, and risk increases as business income increases. You can help your clients avoid an audit by making them aware of the most common audit triggers so they can avoid them or be prepared with the right documentation to defend their filings if audited.
Document discrepancies: Since the IRS gets documentation from other sources which had business with your client, they use a computer program to cross-check all documents against each other. If your client’s documents do not match the reporting the IRS has received from others, the difference will be scrutinized. How to avoid: Impress upon your client the importance of keeping track of all forms (1099s, K-1s, etc.) and filing the correct forms (ex. Form 8300 for transactions over $10,000).
Salary discrepancies: If the IRS sees high profits but low officers’ payroll, they may suspect the owner is trying to avoid paying self-employment tax in exchange for profit distributions. If the owner is paying relatives unusually high salaries, this is also a trigger. How to avoid: Advise your client to keep salaries within the normal range for companies of similar size and success as well as for similar job descriptions.
Income or profit discrepancies: A sudden, dramatic increase or decrease in reported income is likely to be an audit trigger. Reporting losses year after year but continuing to operate will also attract scrutiny. How to avoid: If the sudden income swing is legitimate, you may not be able to avoid attention from the IRS, but make sure your client keeps meticulous documentation to support it.
Paying contractors: Many companies try to hire contractors rather than employees to avoid the matching payroll taxes and healthcare requirements. How to avoid: The IRS has guidelines to help you discuss with your client whether the workers are actually contractors or more like employees. Essentially, if the company sets what the worker gets paid or reimbursed, controls how and when and where the worker does his/her job, and other factors of control, you may wish to discuss with the client about reclassifying the workers before the IRS gets involved.
Write-offs: Write-offs can be an issue with individual taxes as well as businesses. Some write-offs that are often exaggerated and therefore attract notice are travel and entertainment, auto expense, home office expense, and charitable contributions. How to avoid: Clarify with your client what counts as a business expense and help him/her calculate what percent of the car, house, etc. actually goes to business expenses. Suggest an app or program for storing and classifying receipts digitally.
Cash business: Cash businesses can easily under-report and have a higher risk of audit, especially if reported income does not support the owner’s lifestyle or growing bank balances, or if the company’s reported sales or income is not consistent with similar businesses. How to avoid: Encourage your client to keep meticulous records and use some form of digital recordkeeping to assure the IRS that the company is accurately reporting income if audited.
Round numbers: Round numbers mean the person reporting is probably guessing. This is a definite trigger. How to avoid: As with the other triggers, keeping records is key.
Previous audits: This can’t be helped, but it can be prevented in the future if you can impress upon your client the importance of investing the time and money into a digital method for tracking all transactions accurately, compensating employees fairly, classifying them accurately, and reporting honestly.
Many businesses and individuals do not know about these audit triggers, but everyone wants to avoid audits. Use your knowledge about audit triggers, not only to help you help your current clients but also to help you attract new ones.