Top 12 IRS Audit Triggers

As you navigate the tricky and complex tax landscape for your business, you may be worried about the threat of an Internal Revenue Service (IRS) audit. What if you make an error that triggers an IRS tax audit?While the majority of tax returns are processed without further examination or review, there are several factors that may result in your individual or business tax return undergoing further inquiry, or even an audit. Fortunately, with the help of an experienced  business accountant, you can limit your exposure to IRS scrutiny.

What Are IRS Audit Triggers?

Most IRS tax audits are completely random. However, there are some circumstances—known as triggers—that make an audit more likely.

IRS audit triggers are features or characteristics of a tax return that increase its chances of being selected for audit. If your business tax return includes a common IRS red flag, you may be more likely to be audited.

Common IRS Audit Red Flags

Here are some common red flags that may trigger an IRS tax audit for your business.

1: Failing to Report All Taxable Income

If there are any discrepancies in your individual or business tax return regarding taxable income, the IRS may request a review.

2: Earning a High Income

Individual taxpayers with incomes higher than $10 million are far more likely to face an IRS audit than lower-income earners.

3: Making Math Errors or Typos

Math errors or typos on your small business tax return can trigger an IRS audit. A sizable error may lead to an audit. Make sure you don’t put a decimal point or comma in the wrong place.

4: Claiming Too Many Large Charitable Donations

Donating high-value items to charity (those with a market value of $500 or more) or making large charitable donations that do not match up with your income can trigger an IRS audit. Make sure you keep records to document your charitable deductions and consider having a professional appraiser estimate the market value of items you donate to charity.

5: Running a Cash-Based Business

Some types of businesses, such as restaurants, laundromats, and nail salons, rely on cash transactions. Cash-based businesses are subject to misreporting income, especially in cases where employees work for tips. If your business is cash-based and makes large cash transactions or bank deposits, the IRS may take notice.

6: Using the Home Office Deduction

The home office deduction, available to qualifying self-employed individuals or independent contractors, has strict criteria that many people misuse (intentionally or unintentionally). For example, multi-functional spaces cannot be claimed as a deduction. If you claim this type of deduction, the IRS is likely to double-check that you meet the requirements.

7: Deducting Business Entertainment Expenses

The entertainment expense category, which includes business-related meals, travel, entertainment, is a tax deduction that the IRS checks carefully due to rampant abuse. Make sure your business keeps records of the purpose of each expense as well as who was in attendance for every entertainment expense you are deducting. Be prepared to substantiate your tax return.

8: Turning a Large Profit

High-earning businesses, typically with more than a million dollars in revenue, are more likely to be audited by the IRS. If your small business has reached the million-dollar threshold, it’s time to create and implement a long-term tax plan that can hold up to this additional scrutiny.

9: Failing to Turn a Profit

The IRS knows that a startup may not turn a profit in the first year or that your business will earn taxable income every year. At some point, your business should be reporting a profit. If you fail to report taxable income three out of every five years, the IRS may take a closer look at your returns and records.

10: Having Neat, Round Numbers

Neat, round numbers—with everything ending in 0s, 5s, or 10s—may be easier to count and make your  business financials  look pretty, but they’re an indication of rounding or estimating financial data. If the IRS notices your payments and expenses don’t have varying amounts of dollars and cents, they are more likely to begin the auditing process.

11: Making Transactions Involving Digital Assets

Digital assets like Bitcoin and non-fungible tokens are still a red flag for the IRS. If your business makes transactions with digital assets, be prepared to provide documentation for all activity.

12: Holding Foreign Financial Assets

If the IRS suspects that you hold foreign financial assets exceeding $10,000 but have not filed a Foreign Bank Account Report (FBAR), or if the IRS believes you have underreported foreign assets or income on your tax return, you may be subject to additional scrutiny.

What Happens If You Trigger an IRS Audit?

If you receive written notification of a tax audit from the IRS, try not to panic. A tax audit is simply the process of verifying the accuracy of the information shared on your tax return.Instead, seek the expertise of a certified public accountant (CPA) or tax attorney. These professionals can guide you through the tax audit process and identify any common IRS triggers to reduce the risk of your business being audited in the future.

Contact Fisher, P.A. for Business Tax Planning Assistance

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