Here is a list of the TOP 10 things TO do, or NOT do, in order to avoid an audit with the IRS. As many of you can imagine, an audit can be expensive and time-consuming, not to mention, emotionally draining experience. Please take these to heart and I promise if you follow them you can reduce your chances of an IRS audit dramatically.
1.File your tax returns on time (even if you owe and can’t pay). One of the quickest ways to get into an audit is to not file your tax returns. Many taxpayers that don’t have the money for taxes, or don’t think they have enough money, don’t file. They hide and avoid filing. This only causes more problems down the road and personal stress levels you can’t imagine. I highly encourage you to STILL file even if you don’t owe anything or don’t have any income. Penalties are worse if you don’t. You can always get on a payment plan, OR even be placed in an ‘uncollectible status’. Please keep in mind, the IRS is like a boyfriend or girlfriend, if you don’t stay in touch, they will assume the worst. They’ll assume you are cheating on them, and will start to say bad things about you to all of their friends…if you know what I’m saying.
2. Be aware of your industry averages and common expenses. When you file a tax return, you also indicate the industry you work in. This allows the IRS to categorize your expenses and look for abnormal expense levels compared to your income. Obviously, you should never increase an expense because it wouldn’t be noticed, that’s tax fraud. But, conversely, you SHOULD consider reducing an expense if it is far too high and will stand out. I know that sounds crazy. If you are entitled to a tax return, I agree that I think twice or three times about reducing it. The practical approach is that you better have all of the receipts, support and ‘your ducks in a row’ before taking a large expense for something uncommon for others in your same business.
3. Attach additional statements and comments. When necessary, include additional information with your return to substantiate expenses and oddities that might exist. If your file gets handed off to an agent for further review, a real human can sometimes choose to bypass your return for an audit because you already provided the support the Revenue Agent would be asking for. I realize this is hard to know when it’s the right time to do this when you are filing your return with software with a DIY (do it yourself) approach. However, if your going to go down that path, make sure you study a few maps along the way.
4. Avoid Schedule C. Having a small business is a great tax-saving strategy, but reporting it as a Sole-Proprietorship can dramatically increase your chances of an audit. Choose to file as a partnership or corporation when economically feasible. If you have consistent losses, it even gets worse. The IRS could easily argue that you are operating a ‘hobby’, not a business- not good. On the other hand, if you are making big money, you would see A LOT more savings with an S-Corporation and reduce your chances of an audit by 15x (statistics show). This would allow you to be more aggressive with write-offs that are honest deductions, but you don’t want the attention. Check out this video about S-Corporations:
5. Issue your 1099s. This is a huge area of concern for the IRS. When you are claiming deductions for paying sub-contractors, you need to issue the proper 1099s in January following proper reporting procedures. If you already missed the deadline this year. Don’t let it happen again. Request W-9s from all subs BEFORE you pay them. Read this article on proper procedures for hiring subs: https://markjkohler.com/1099-rules-for-business-owners/
6. File payroll reports and remit your payroll withholding. If you have employees, don’t even get me started regarding withholdings. This is sacred money in the eyes of the IRS and you must never get behind on these reports or remitting withholdings. Moreover, if you own and operate an S-Corporation, it’s just as critical. You may think that because you don’t have other employees, you can be more lax on yourself as an employee of your S-Corp – wrong. You want the tax benefits of an S-corp you have to play the game…that means payroll. The IRS will quickly notice if you are sitting on the sidelines when your supposed to be in play. Get a payroll service…end of discussion.
7. Avoid round numbers. This should be a no-brainer, but you would be surprised how many tax returns at our firm we discover with prior write-offs with line times with large round numbers. For example, $400 rather than $379.22. This is a major red flag. How many people actually spend $400 on office supplies in a given year? I don’t think you could go through Staples and create 1 or 2 purchases that exactly add up to $400 even if you tried. Be accurate and keep good records so you aren’t rounding and guessing later.
8. Don’t inflate the home office deduction. Take the home office deduction and don’t be afraid of it, but also don’t get too aggressive. The home office deduction is legit even if you have an S-Corporation. Just have a procedure and remember “pigs get fat and hogs get slaughtered.” Don’t get greedy. Here’s a helpful article on the topic: https://markjkohler.com/maximizing-the-home-office-deduction/
9. Avoid taking excessive Dining, Travel and Entertainment expenses. I’m the first one to advocate taking a healthy deduction for dining, travel and entertainment, HOWEVER, these expenses should look normal, well-balanced and conform to your income level and industry. For example, if you run an eBay business out of your basement in the evenings, I don’t think daily dining and golfing expenses are going to fly. However, if you are a sales rep on the road peddling products, those type of expenses will appear to be less aggressive appear to be standard. Now, with that said, the rules changed in 2018 and it’s important you know how to tackle meals and entertainment in the future: See here: https://markjkohler.com/writing-off-dining-and-food-expenses-in-2018/
10. Don’t stick your head in the sand if you get a notice from the IRS. So many taxpayers get a notice from the IRS and hope it will go away if they ignore it. Yet…it’s only wishful thinking. You make it FAR worse if you ignore the IRS’s letters or requests for additional information. Just like item #1 above, if you don’t file, OR don’t respond, the IRS will assume the worst and get aggressive quickly. Next, seek professional advice. You never know if the letter/notice you received from the IRS is serious. Sometimes, they are simple, easy and no big deal…but only a seasoned professional dealing with the IRS on a regular basis will know.
Bottom line, don’t be afraid to take an expense that you’re entitled to, especially if you kept good records. But also make sure you’re filing your returns on time, AND they don’t stand out. This is just like high school prom, you want to show up, but not draw attention to yourself. You want to be the cool kid in the corner and not act like Anthony Michael Hall dancing awkwardly in front of the bleachers. You’ll just end up under a coffee table later in the night unable to breathe.
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.