Nine Ways to Reduce Your Chance of Being Audited

No business wants to face an audit, it can be a surprise but you can take some steps to avoid the chance that the IRS will come knocking on your door.

1. Have a tax professional prepare your return
Pros know the tax rules and are unlikely to make ignorant or illegal mistakes, so returns done by professionals are audited less than those from individuals. If you are audited, your tax pro can handle the negotiations with the IRS for you or coach you to represent yourself.

2. Show all names and identification numbers EXACTLY as they appear in government records.When part of a name or number doesn’t exactly match what’s in the official Social Security or IRS database, it kicks your return into the error pile. If you or anyone else you list has changed part of their name due to marriage or divorce, stick with the old name until the record is updated at Social Security. These little mistakes can open the Pandora’s box to bigger problems.

3. Check your math and numbers carried to other pages. Your tax professional’s software will do this automatically, but if you insist on doing it yourself, get a friend with fresh eyes to double check your entries page to page.

4. Break down any huge total for just one expense item. If you list a disproportionately fat total for one type of expense, it’s sure to raise red flags — especially if you call it something vague and general, like “Outside Services”. Break that big total down into smaller components with more specific descriptions.

5. Don’t write off 100% of home or car expenses for business. The IRS is particularly sensitive to this issue because there have been some illegal work-at-home scams that told people to write off ALL their home expenses as business expenses. The scam company made a lot of money off these gullible fools and caused a lot of them to get audited. It’s too bad so many people fell for what they should have been suspicious of.

Remember, anything that sounds too good to be true probably is!

If you have an office at home, it really only takes up part of the total space, only uses a portion of the utilities and so forth. Don’t get greedy. If you deduct 100%, what you’re trying to do will be instantly obvious to the IRS. Due to the excess cheating they’ve seen with this deduction, they are quick to spot suspicious deductions. Be reasonable and stick to what you can back up with square footage figures.
Car expenses, too, would likely only have some portion that qualify as a business deductions. Unless the car is owned by your company and is ONLY used for business — no home to business commuting — you’ll need to differentiate business from personal use, and back up your percentage with mileage records.

6. If you work from home, try not to show more expenses than income.
This would be another tip-off that you might have fallen for one of those work-at-home scams. Or that you were not serious enough about being in business to make a profit. If you don’t show a profit in three of the last five years, the IRS might determine your so-called business was just a hobby and disallow the business deductions you’d taken.

7. Don’t show so little net income that it appears you have nothing to live on.
The IRS knows you must meet your living expenses somehow, so if your total family income looks too low to do this, the IRS may ask you how you survive — especially if you show minuscule income for several consecutive years.

If your spouse is working, that salary will be listed on your tax return, showing clearly there’s some income coming in to offset low-income years you report for your business. Or if there’s something in your return that indicates you have a pile of money around you can draw from — shown by significant interest or dividend income, or a recently sold property — then the “how do you survive” question is less likely to come up.

8. Don’t try to call your employees independent contractors
If you control how someone works, they are your employee, not an independent contractor. You must withhold tax from their checks, pay various employer taxes and send these monies on schedule to the IRS. If your “independent contractors” are later deemed to be employees, you’ll face huge back taxes and penalties, which could literally break your business.
This is one of the hot problem areas in small businesses, so the IRS and various state agencies are on the lookout for indications of violation. If the type of product or service your company provides requires even a small number of people to regularly work on your site in coordination with each other, these people most likely must be classified as employees.
We’ve just briefly generalized the employee situation, but if this sounds like it might pertain to you, it is imperative that you educate yourself in detail about the letter of the law. Ignorance is not accepted as a viable excuse for non-compliance.

Independent Contractors vs. Employees

9. Report all your income
This should go without saying, but many people think they can get away with not reporting all the income they receive. Hello, this is the 21st Century! The IRS has very sophisticated technology that compares the income total you report to information they receive from other sources. Plus they use computer analysis and statistical studies to spot irregularities.

Sorry, No Guarantee

There’s no way anyone can guarantee you can avoid an audit. The IRS sometimes audits everyone within a certain geographic area who’s in a particular field — such as all babysitters or all auto dealers — in order to develop statistical data on that industry. So you never know when your number could come up.
But generally, if you don’t make silly errors or try to take deductions that defy logic, you’ll greatly reduce the likelihood of being audited. And you won’t wipe out your tax savings with back taxes and penalties.