No one wants to endure the pain of going through an audit. It’s time consuming, frustrating, and a bit scary.
At the end of the day, some audits are random. There is no way of avoiding an audit with 100% certainty. However, there are some actions you can take to be sure you’re not flagged with the IRS which will decrease the likelihood of being audited.
My best piece of advice is to document everything. The more documentation you have, the less you’ll need to “convince” an auditor that an expense is legitimate.
1. Red flag: 100% business use vehicle. If you are deducting any vehicle expenses on your tax returns, you want to be very realistic about how much of the vehicle is used for business and personal expense. Cars are rarely 100% business-use unless it’s purchased in an industry where revenue is based on using the vehicle (landscaping trucks, delivery vehicles, etc). If the car or truck is used for anything personal (to and from work, grocery store runs, etc) then you cannot deduct 100% of that vehicle’s expenses. By tracking the mileage used for business, you’ll be able to accurately calculate the business-use percentage.
2. Red flag: unreasonably large amounts of charitable donations. Shifting income to non-profits is one of the most used forms of tax abuse so the IRS has their eye on large charitable donations. When you donate, keep all documentation and have full transparency of what/how much you donated. There should be a clear purpose or intent for the donation. (Also be sure the non-profit you are donating to is registered with the IRS by visiting apps.irs.gov/app/eos)
3. Red flag: multiple years of losses. If you are running a business (or a non-profit) and have a loss in more than 2 out of the last 5 years, an audit is likely. The IRS wants to see that you are running the business with the purpose of turning a profit. If not, then you might be using the losses from that business to offset income from another source.
4. Red flag: continuous late filing. If you are continuously filing late (different than an extension) you might be on the radar. Any error on your tax return or in your business will fall under greater scrutiny. Easy to avoid – file on time or within the deadlines of your extension.
5. Red flag: cash heavy businesses. This isn’t something you can stay away from necessarily. If you run a restaurant, salon, valet company, etc. then your business is just cash heavy by nature. The best thing to do is to (I’m getting repetitive here) document everything. The IRS keeps an eye on these businesses so take accounting seriously. Report each dollar that goes in and out of the business.
Overall, focus on staying organized when it comes to the money movement in your business. Use an accounting system to track your income and expenses, save your receipts (find a receipt app, those are a life saver!) and be reasonable about the deductions you take on your tax return.