Is your business waving a red flag at the IRS?
The chance the IRS will target your business for a federal tax audit is usually low. However, if your tax return for your business includes certain red flags, you boost your odds of being audited. Here are a few of the most common audit triggers that are likely to grab the attention of the IRS.
Continuous losses. If you report a net loss on a Schedule C in more than two out of the last five years, the IRS may consider your business a hobby. If deemed a hobby, you can deduct expenses only up to the amount of your hobby's total income. Enjoy rebuilding cars? Great. But if you never turn a profit, don't expect the IRS to consider it more than a hobby.
Questionable travel and entertainment expenses. This is an area that is frequently abused, so IRS auditors tend to examine travel and entertainment costs with greater scrutiny. If you claim expenses for lavish parties, hunting trips to Alaska, or taking your buddies to the ball game, be sure you can thoroughly document a legitimate business purpose.
Failure to report income. If you own a business that transacts mostly in cash, such as a convenience store, nail salon, or small restaurant, the IRS will be on the lookout for unreported revenue. No business operates for long without sufficient revenue to cover its expenses. If the IRS suspects that revenue is under-reported, you could face thousands of dollars in taxes, fees, and penalties.
Round numbers. It happens: Sometimes your sales figures actually are big round numbers, but if the math on your business tax return can be computed in your head without benefit of a calculator, IRS auditors may be skeptical. Report actual amounts. Don't fudge.