By: Pamela Martinez, JBS Corp.
Becoming a small business owner is no easy feat and can often be intimidating. We see it all the time as tax season rolls around and owners scramble to complete their tax return. Although the odds of a tax audit are low, small business owners are encouraged to take the precautions against audit risks. To aide in doing so, we have compiled a list of avoidable actions that can potentially put your business at risk.
Filling a Schedule C
A Schedule C is an IRS self-employment form that allows a small business owner to report their gross income, allowed deductions, and report their profit. However, because individuals who file a Schedule C are typically the sole proprietor of their business—and forms are often incorrectly completed—it is difficult to confirm their filings’ accuracy, which unfortunately places individuals who file Schedule Cs at a higher risk of being audited than corporations. Individuals who file a Schedule C should choose their deductions wisely and be wary of the fine line between personal and business-related expenses. The audit risk of a Schedule C is said to be double that of a corporation.
Over Inflated Travel and Meal Deductions
However tempting it may be, claiming disproportionately large travel and meal deductions is a sure way of attracting the IRS’s attention. Often business owners get overly ambitious and write-off possible leisure expenses as business expenses. The IRS does note these actions, so it’s best to be cautious of the expenses you choose to claim. The expenses you do claim should be verifiable by records of all receipts, parties involved (e.g., clients, colleagues, etc.), and the reason for the expense (e.g., prospective client lunch). With this information in hand, you’ll be prepared to pass an audit.
Excessive Business Vehicle Deductions
If you claim 100% business usage for your vehicle, the IRS will likely consider you a candidate for auditing. Unless you have a business-specific vehicle (i.e., delivery truck, cargo van, etc.), it is improbable that 0% of the miles on your car are personal. These deductions can be made by way of actual vehicle expenses or standard mileage rates; regardless of which you claim, both will provoke the same response. You’ll also have to keep detailed documentation of mileage logs and reasons for every trip for depreciation purposes. Thanks to modern technology, this can be done easier than ever. MileIQ provides a cheap, easy way to track personal & business miles with a simple app on your phone.
Constantly Filing Late
There are limited scenarios in which being late generates a positive response; filing your business tax return late is not one of them, especially when you begin to habituate it. Not only will you be penalized with fees from this, but a revenue agent could also conclude that your business is disorganized and can result in unwanted attention.
Low Compensation to Officers (Your Salary)
Some small business owners usually underpay themselves to avoid many payroll costs, including payroll taxes—ultimately saving themselves a few thousand dollars a year. According to the IRS, you must pay yourself a “reasonable compensation,” relative to your experience, hours worked, and area of specialty. The salary you give yourself, and any other owners should equate to the industry standard or the cost of hiring a replacement for your position. Anything below that figure raises enough suspicion for the IRS to audit your business.
Cash Transactions
In the digital age, having an unreasonably high number of cash transactions is guaranteed to raise red flags. Nevertheless, if your business accepts a high-volume of Cash transactions or you’re making large cash transactions for business purposes (e.g., vehicles, investment property, etc.), keep in mind that all cash transactions exceeding $10,000 are reported to the IRS.
Failure to Report Taxable Income
The IRS does not handle cases of unreported income lightly. The U.S. tax codes require that all forms of taxable income be reported to the IRS, including any transactions where you accept funds in exchange for services. Failure to do so can result in paying sizable penalties and a thorough tax audit.
The chances of being audited are considerably low but don’t give the IRS a reason to come snooping around your business. Taxes are dreadful and confusing, and many people search for methods to avoid paying them. But, instead of trying to save a few bucks by adopting practices that put your business at risk of being audited, take a look at our Tax Avoidance vs. Tax Evasion article to uncover potential ways to minimize your tax payments, legally.
