What Triggers a Business Tax Audit

Although the first quarter tax day of 2023 has passed, your second quarter payment will be due within a matter of weeks on June 15^th, 2023 – plus, you still have a chance to be audited within three years of filing. A tax audit is an investigation of a company’s financial information to ensure they accurately report their taxes. Learn more about the types of audits in our blog “What Does It Mean to Get Audited?”.

While your chance of an audit can vary depending on your business, it’s still a stressful experience. Understanding what triggers an audit and how to prepare can help alleviate some of that anxiety. Learn what triggers an audit so that you can avoid it in the future and how to best prepare if you do get audited. An audit can be an excellent opportunity to make positive changes to your business. At All About Businesses, we’re here to help you through the auditing process and keep your taxes to reduce your audit risk.

What Triggers an Audit?

In addition to statistical random selection, the IRS may audit your businesses based on the audits of your partners and vendors. Certain factors can increase the likelihood of an audit. 

1. Unusual deductions: Claiming a high amount of deductions, especially higher than in previous years, or similar businesses can raise a red flag for the IRS. High business meals, travel expenses, home office deductions, and charitable contributions may warrant a second look. The IRS has written guidelines and a general idea of how much businesses should deduct for these expenses, which means claiming in excess can trigger an audit.
2. Schedule C Sole Proprietors with high income: Schedule C sole proprietors that generate a high income are more likely to be audited. These self-employed individuals likely have more complex tax returns, leaving more room for errors. There may also be unique circumstances, such as home offices or cash businesses, that the IRS will want to ensure are appropriately reported.
3. Inconsistent reporting: The IRS will look at similar businesses in the same industry and ensure the reported income is comparable. Companies with significantly higher or lower incomes than others in their industry may be flagged for an audit.
4. Cash transactions: Businesses primarily using cash transactions are more likely to be audited because cash is more difficult to track. If money is frequently deposited just below the $10,000 mark, that is another red flag for the IRS since it is a tactic to avoid federal reporting requirements.
5. Hiring Solely Independent Contractors Over Employees: If your business only hires independent contractors or has a small pool of classified employees, audit risk is higher because the IRS may believe you are misclassifying workers, which leads to unpaid payroll tax or benefits.
6. Math Errors: Math errors on tax returns are another audit risk. Consistent errors can indicate an attempt to avoid paying your entire tax liability. Similarly, if the numbers on a tax return are too “clean”, meaning they end in round numbers, the IRS may view that as a sign of math error or incorrect rounding.
7. International transactions: Similar to cash transactions, international transactions are more likely to be audited. The IRS is interested in preventing tax evasion related to international income.

How to Prepare for an Audit

Although it isn’t possible to completely eliminate the possibility of an audit, you can take steps to lessen the chance. You can also take steps to prepare for the event your company is selected for an audit. The IRS’s website has a large number of resources to help you ensure you understand the audit process. The following are some tips for preparing for an audit:

1. Keep accurate records: Keeping correct financial records should already be an essential part of running your business, but it is imperative in the event of an audit. In the event of an audit, you’ll need documentation such as receipts, invoices, and bank statements to support what you’ve reported.
2. Hire a professional: An All About Businesses virtual bookkeeper can help you keep your financial information organized and accessible. We’ll also help you navigate the audit process, including answering questions about the information you need to provide the IRS.
3. Respond promptly: If you receive a notice from the IRS that you’re being audited, respond promptly. Having financial records organized helps you respond in a timely manner and protects you from late penalties and fees.

Addressing Audit Findings and Improving Your Business

If the IRS finds discrepancies in your tax return during an audit, they’ll send you a report detailing their findings. You then have the opportunity to address the audit findings. All About Businesses’ virtual bookkeepers can be a valuable resource during an audit by helping you with your response, representing your business to the IRS, and in some instances, organizing additional documentation. We’ll also walk you through any other taxes, penalties, and interest you may owe. If you are concerned you will be audited and want to take time to prepare, All About Businesses can help by ensuring that your financial records are accurate and up-to-date.

An audit can provide an opportunity to identify areas for improvement in your business. Audit findings may show you weak points in your business’s handling of finances, including document organization, financial statement accuracy, compliance with tax regulation, and fraud protection. Your business can use the findings from the audit to improve in these areas. Taking action can help prevent future audits and make your business more efficient, reducing expenses and increasing revenue. Keep All About Businesses on board even outside tax season to keep your financial records organized and feel confident about the accuracy of your business’s book.