Small Business Owners: Tips to avoid an IRS audit

The IRS is contacting you to audit your income-tax return. This can cause any small business owner’s stomach to do a flip.

Although there is no certain way to avoid a tax audit, there are ways to make it easier on you and you business.

What provokes an audit? The IRS may audit a tax return for any reason. But those who report simple income and deductions that may be easily verified are less likely to attract the interest of the IRS.

Just over 1 percent of all returns were audited in the 2012 fiscal year, according to the IRS. Taxpayers with annual incomes of more than $1 million, or people with more complex deductions, were subjected to more audit coverage, at a rate of almost 10.3 percent.

Fortunately, you don’t have to be fearful of an audit if you follow these tips:

1. Know what you are filing. Staying current on the tax laws is difficult. Knowing how depreciation works, how to calculate home office expenses, and how to figure out mileage are not inherent skills of most small-business owners. If you are unsure of how to properly fill out your tax return, it can be worthwhile to hire a tax professional to do it for you. You may be claiming deductions you shouldn’t be or missing out on some you should be claiming. You are still responsible for any mistakes or omissions, even if a tax professional handles the return, so it is worthwhile to have a basic understanding of the process.

2. Double-check your return before filing. The IRS states that the vast majority of changes on tax returns after an audit are due to mathematical errors. Using tax software like TurboTax helps to cut down on errors, but it can’t prevent them entirely. Triple-check your return to make sure everything makes sense before popping it in the mail or e-filing.

3. Keep original documentation for seven years. Most audits are conducted on the past year’s tax return, but auditors may go back three years if they believe that there are systemic errors in your returns or six years if they believe you have large understatements of taxable income. They can go back in time indefinitely if they think you’re trying to defraud the IRS. Keeping all documentation that supports your tax returns for at least seven years ensures that you can support any claims. If you have lost or destroyed the documentation, the IRS can disallow your claim and you will have to pay not only the extra tax, but also penalties and interest, which can add up quickly.

4. File amended returns for any errors you notice after filing before you are audited. If you come across an error or omission in your return, correct it right away. Do not wait for a potential audit. File a 1040X return to amend the original. You will still have to pay any extra tax due and interest, but the IRS offers some leniency with penalties for innocent errors. Taking the chance that the IRS won’t find the error will merely add to the stress you likely already have as a small-business owner.

5. Hire an experienced CPA to handle your tax audit. There are several good reasons to get a professional involved in your tax audit. They navigate audits on a regular basis and know what the auditor is looking for. If the audit is complex or involves scans of bank accounts and other invasive procedures, the CPA can help to minimize the inconvenience and scope of the exam. Let the professionals handle your income taxes, so you can focus on running your business.

Notable references:
- blog post by Angie Mohr

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