Reducing Audit Risk: Five Key Strategies for Business Owners

What triggers an audit?

As entrepreneurs and business owners, we have enjoyed relatively low audit rates from the IRS in recent years due to their lack of funding. However, the tides are changing as the IRS has received significant funding and is ramping up its efforts to target small business owners. IRS audits are increasing and small business owners can be at a high-risk rate without these important steps they can take.

In this blog post, we will discuss five essential strategies to help you lower your audit risk and navigate potential audits with confidence.

1. Let Professionals Handle IRS Communication

When facing an IRS audit or notice, it is crucial to avoid direct communication with the IRS. Similar to talking to the police during an investigation, it is advisable to engage an attorney or a Certified Public Accountant (CPA) to handle the correspondence on your behalf. This approach minimizes stress, limits the flow of communication, and reduces the risk of inadvertently saying something that could raise additional concerns.

2. Have a Professional Prepare Your Tax Return

The involvement of a professional in preparing your tax return can significantly reduce your audit risk. Instead of submitting a return with only your signature or relying on non-CPA preparers, engaging a reputable CPA provides several benefits. The IRS recognizes the rigorous review and compliance standards followed by CPAs, giving your return more credibility. Moreover, a CPA's involvement ensures the availability of work papers and thorough documentation, increasing the confidence in your filing.

3. Utilize Separate Business Tax Returns

To lower audit risk, consider filing business income on separate tax returns instead of reporting it directly on your personal tax return. For instance, if you have business income, it is advisable to file it on an S Corporation (SE corporation) return, while rental income should be reported on a partnership return. By doing so, you not only reduce red flags on your personal return but also limit the IRS's ability to audit the separate income information easily. Multiple audits targeting different entities are often less likely to occur, especially if they involve separate business returns handled by different IRS teams.

4. Thoughtful Expense Reporting

Strategic reporting of expenses on your tax return can minimize audit risk. Avoid disproportionately high expenses in relation to your income, as this may raise concerns during the IRS's initial algorithmic review. By dividing significant expense categories into smaller components and carefully describing expenses with ordinary and necessary language, you can reduce the likelihood of triggering a manual review of your return. Ensuring that your expenses align with industry standards and reflect legitimate business operations further strengthens your position.

5. Document Everything

Maintaining accurate and comprehensive documentation is vital in reducing audit risk. Unlike larger businesses that typically have meticulous records, many small businesses lack well-kept books. By maintaining tight records, such as credit card and bank transaction histories, you provide solid evidence for your expenses. Additionally, ensure you have up-to-date corporate records, including minutes from annual shareholders meetings and accountable plan expenses for home office deductions. Well-documented records and financial books demonstrate your commitment to compliance and can serve as a reliable resource during an audit.

Conclusion

Implementing these five strategies can significantly lower your audit risk as an entrepreneur or business owner. By avoiding direct communication with the IRS, engaging a professional for tax preparation, utilizing separate business tax returns, thoughtfully reporting expenses, and maintaining comprehensive documentation, you can sleep well at night knowing you are prepared for potential audits. Remember, reducing audit risk is about being proactive and ensuring compliance while safeguarding your financial well-being.

If you have any questions or seek further guidance on audit risk or tax strategy to optimize your financial situation, feel free to visit our website. Take advantage of our free trainings or schedule a discovery call to explore how our tax and financial strategies can help you achieve greater financial freedom and security.