How to Avoid Tax Audits When Running a Small Business

Contrary to popular misconception, small businesses are frequently targeted by the Internal Revenue Service for tax audits. As anyone who has ever been through a tax audit knows, the experience can be a major ordeal - even for those who have done nothing wrong. Therefore, small-business owners should take the time to learn about the steps they can take to help protect themselves from the risk of being audited by the IRS.

Keep Business and Personal Accounts Separate

For any small business owner, particularly sole proprietors, the line between business and personal expenses can easily be blurred. However, keeping business expenses separate from personal financial activity is crucial to avoid raising red flags that could trigger an IRS tax audit. This is because the IRS keeps a lookout for business owners who report personal expenditures as business expenses and is more likely to audit business owners who they suspect of doing so. To help keep expenses and funds properly categorized, it is a good idea to use a separate bank account and credit card for business-related expenses and use them only for that purpose.

Report Income Fully

While it may sound obvious, another important step that can help small-business owners prevent tax audits is simply to report their entire income at tax time. Many business owners underreport their income without intending to, often through common accounting errors such as reporting net revenues rather than gross revenues. For instance, a business owner who accepts credit cards may erroneously report only the net payments he or she receives after credit card fees are taken out, instead of reporting the gross payment that includes the fees. Instead of subtracting the credit card fees from revenue in this manner, business owners can claim them as a deductible business expense and thereby reduce their taxable income.

Be Specific When Claiming Deductions

As tedious as it may seem to spell out each and every tax deduction, going through a tax audit is far worse. Small-business owners should be careful to spell out any tax deductions they claim, particularly obscure or unusual deductions. Being specific when claiming a deduction allows the IRS to verify the deduction claimed, potentially avoiding an audit. In contrast, business owners who claim miscellaneous deductions may make themselves more vulnerable to tax audits since the IRS has no way to verify the legitimacy of the deductions.

Seek Professional Help

Another wise move for small-business owners who wish to minimize the possibility of being audited by the IRS is to seek help from professionals such as accountants and tax attorneys. Particularly when forming a new business or restructuring an existing small business, a knowledgeable tax attorney can provide valuable advice to business owners on how to maximize their tax benefits and avoid the missteps that can lead to a tax audit.