Top Mistakes To Avoid During An IRS Audit

Smart Moves To Keep Your Business Out Of Trouble

As businesses began to recover from the challenges of the COVID-19 pandemic, a new hurdle emerged: IRS audits. In late 2020, the IRS announced plans to increase small business audits by 50% in 2021. Since then, audit activity has steadily intensified. If Uncle Sam has already come knocking, avoiding common mistakes is crucial.

Top Mistakes To Avoid During An IRS Audit
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Top Mistakes To Avoid During An IRS Audit
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One major pitfall is failing to report all income. IRS auditors have long focused on uncovering underreported income. They pay special attention to businesses that deal heavily in cash. They also scrutinize businesses receiving miscellaneous income reported via 1099 forms. To avoid trouble, business owners should proactively track and document every source of income. Invoices, sales receipts, profit and loss statements, and bank records are all useful tools to substantiate reported amounts.

Another red flag is reporting consistently high business losses. Businesses often run at a loss in their early years. Still, the IRS can raise concerns if a company never turns a profit. In fact, the IRS can classify your business as a hobby. This happens if your business does not profit in at least three of the past five years. This classification can lead to the disallowance of certain deductions.

Equally problematic are deductions that lack proper substantiation. For example, claiming a home office deduction requires that the space be used exclusively for business. Similarly, it’s suspicious if a business earning $50,000 claims $10,000 in charitable donations. It also raises suspicion if auto expenses are written off for a personal vehicle used as the only car. To satisfy auditors, businesses must show clear documentation. This includes mileage logs and receipts. These documents must directly support the figures claimed on the tax return. If original records are missing, seek other sources like vendors or landlords with relevant copies.

Many business owners also overlook the importance of detailed expense reports. Create an expense report for business purchases with a credit card. Include account numbers and attach supporting documentation for each charge. Auditors pay close attention here since it’s easy for personal and business expenses to blend.

One of the most avoidable mistakes is failing to keep separate books and accounts. Running personal expenses through business accounts—or the opposite—can signal poor financial practices and raise red flags during an audit. Separate bank accounts and credit cards for business operations are a must.

Finally, attitude matters. Treating an IRS auditor as an adversary is a recipe for friction. Auditors are simply doing their job, and approaching the situation professionally and courteously can go a long way. Be punctual. Dress appropriately if visiting their office. Instruct your staff to answer questions honestly and thoroughly if an audit occurs at your business location.

If you need help preparing for an upcoming IRS audit, The JLiz Group is here for you. They offer guidance on how to protect and organize your financial records. Call at 1-702-857-7825 or visit contemporarytaxspecialists.com. 

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