5 common red flags that could get your business audited by the IRS
In large and small companies alike, the prospect of an IRS audit sends shivers down the spine. Sometimes an audit is simply the product of poor luck and random chance. But in other cases, something in the filing process raises concern.
Thorough, accurate recordkeeping proves the best defense should a tax person come knocking on the door. However, the ideal scenario, of course, is to avoid becoming the subject of an audit to begin with. While you can’t eliminate all risk of audit, you can decrease it.
There are five common red flags companies should watch out for or risk raising the alarm at the IRS. Knowing these makes it easier to take action to lower the odds of an audit.
Questionable expense reporting
Large HR departments and sole proprietors both need to fully understand what a company can and cannot claim as a deduction. The IRS stays alert to potential problems in this area, knowing that organizations frequently make mistakes or fail to follow guidelines.
Potential pitfalls often include:
- Failing to separate business and pleasure (such as trying to write off a vacation as a business trip).
- Not keeping up on the most current information regarding expenses incurred for business-related meals and entertainment.
- Handling business vehicle claims improperly, such as trying to deduct both actual expense and IRS standard mileage rate instead of choosing between the two.
- Incorrectly figuring home office deductions when self-employed.
- Posting a much larger number of deductions on this year’s return as compared to previous years (you’ll need to figure out why and be ready to explain it to the IRS if asked).
- Taking more deductions than would be expected for your tax bracket (technology allows the IRS to compare your company’s number and amount of deductions to similar businesses).
With the rise of the gig economy, it is not unusual for modern businesses to obtain services from both employees and independent contractors. Proper classification, however, is a must because of the difference in tax situations. The IRS does not require businesses to withhold taxes from contractor paychecks (self-employed individuals handle their own tax responsibilities), but they do mandate it for each employee organizations pay. Thus, improper identification impacts payroll taxes, paychecks, and sometimes even labor law compliance.
“The IRS is likely to look into businesses that pay more independent contractors than employees if it believes the business is trying to avoid payroll taxes,” says Shelli Woodward, financial controller at Merchant Maverick. “Make sure that you are following the guidelines identified by the IRS and Department of Labor to properly classify workers.”
Unsure about someone’s classification? Check out the IRS’s Independent Contractor (Self-Employed) or Employee? for guidance. It explains behavioral, financial, and relationship factors to consider when making the distinction.
A teacher receiving a tardy term paper wonders about the student’s commitment to putting forth his best work. The same thing applies with the IRS. Don’t give the government reason to question your company’s seriousness about following rules.
“When tax forms are filed late, the IRS notices, and it can give the impression that your financial records are not organized. Make sure you meet all filing deadlines throughout the year or find a payroll platform that will assist you in making sure all filings are completed,” Woodward says.
Filing for an extension is better than being slapped with penalty fees. Highly preferable, though, is starting the process earlier to avoid the situation entirely.
Making reporting errors
In a similar vein, a company’s reputation comes into question when it submits sloppy information. Looking like you operate haphazardly and lack attention to detail raises eyebrows.
“When tax forms are filed with incorrect employee SSNs and math errors, it raises a red flag to the IRS. Before filing tax forms, double-check your entries. This includes making sure all SSNs are accurate, overtime wages were calculated properly, correct tax rates are being used, and all math calculations are correct,” Woodward says.
Pressed for time, some filers opt to submit a less-than-perfect return and clean up any mistakes later. Filing an amended return, however, puts your organization’s information through the screening process again. Do things right the first time rather than give the IRS a second chance to choose your company to audit.
Failing to be honest
Finally, when you know a behavior is wrong, don’t do it! Avoid temptations such as not reporting all cash payment received or fudging here and there on expense deductions. Technology gives the IRS more outlets than ever for catching potential lies and inquiring about them. Don’t put your company in that uncomfortable position.