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Common red flags that trigger a small business audit

On Behalf of | Mar 2, 2024 | Blog |

Operating a small business comes with various responsibilities. One key aspect is managing your finances so you remain compliant with tax regulations.

Understanding potential red flags that might trigger an IRS audit is important for ensuring your business stays on the right side of the tax authorities.

Inconsistent income and expenses

Discrepancies between reported income and expenses can raise eyebrows during an audit. Ensure that your financial records accurately reflect your business transactions to avoid drawing unnecessary attention.

Along the same lines, any large, unexplained fluctuations in income from year to year may attract scrutiny. Maintaining consistency and providing explanations for any significant changes can help safeguard your business from potential audit triggers.

Be aware, too, that intentional or unintentional omission of income is a significant red flag. You must report all sources of income accurately to prevent potential audits.

Excessive deductions

While deductions help reduce taxable income, excessive or inflated claims can cause problems. Ensure the legitimacy of all deductions, supported by proper documentation and directly related to your business activities.

While home office deductions are acceptable, they can be closely scrutinized. Be meticulous in calculating and documenting these deductions to avoid triggering an audit.

Excessive claims for business meals and entertainment expenses may also raise suspicion. Keep detailed records and ensure that these expenses are reasonable and directly related to your business activities.

Mismatched information

Consistency is key. Any discrepancies between the information on your tax return and other documents, such as financial statements or 1099 forms, could raise concerns. Ensure that all records align to avoid red flags.

Independent contractor classification

Misclassifying employees as independent contractors or vice versa can catch the IRS’s attention. Ensure that your workers are properly classified, that you are up-to-date on independent contractor regulations and that you have met all tax obligations related to their employment status.

Staying informed about potential triggers for a small business IRS audit keeps your enterprise running smoothly within the bounds of tax regulations.