After incorporating your small business and working hard to collect private clients, the last thing you probably want to deal with is an audit letter from the IRS. Unfortunately, just because your business is small doesn't mean that it isn't subject to the same tax penalties as larger, multi-million dollar businesses. Here are two red flags that might prompt an IRS tax audit for your small business, and how you can avoid trouble:
1: Making Too Much Money
If you are like most business owners, you might gleam with excitement the day that you realize your business is starting to pick up. After working to build your brand and hire additional employees, you might feel happy when you notice that your balance sheets have broken the 6-figure range. Unfortunately, the more money you make, the more interesting your company will be to the IRS.
Believe it or not, businesses that make over $200,000 a year have an audit rate of 2.71%, which equates to about one in every thirty-seven returns. Although that 6-figure profit might have to be split between all of your business partners or divvied up to pay your employees, the mere fact that your company made over $200,000 may increase your risk of an audit.
If your business starts to pick up, and you suspect that you may break the $200,000 threshold, do yourself a favor and hire a tax attorney, such as Wiesner & Frackowiak, LC, right away. Ask your lawyer to comb through your financial records and your books with your accounting team to make sure everything is in order. If possible, think about limiting your business activity to keep your proceeds under $200,000 for the year to avoid scrutiny. For example, you might hold off on completing a major sale until after the fiscal year ends, or wait until the New Year to sell off extra equipment.
2: Excessive or Incorrect Deductions
While most business owners realize that they shouldn't use business funds to pay for that luxury vacation to the Bahamas, some of the more mundane expenses might also raise red flags for the IRS. If you take excessive deductions or don't record things properly, you might be asked to pay back taxes. Here are a few examples of common mistakes small business owners make when itemizing deductions:
- Office Space: You aren't a millionaire quite yet, which is why you might be running your business out of the garage. Unfortunately, if you write off that portion of your home mortgage on your taxes, you might be in trouble, even if you honestly use the space for business purposes. Because the law states that home office space has to be used regularly and exclusively for your business, any space that doubles for another purpose isn't an allowable write off. For example, if you work from your living room, where your family frequently watches television after you get off work, the space wouldn't be considered "exclusive."
- Charitable Contributions: Because charitable donations, such as donations to homeless centers, churches, or charities, can be written off on your taxes, many business owners run these types of donations through their business checking accounts. Unfortunately, writing off too large of a portion of your yearly profits in donations might prompt concern from the IRS. To stay on the safe side, experts suggest keeping charitable donations under 3% of your yearly profits. For example, if your business makes $100,000, ideally, your charitable donations write-off should be under $3,000.
- Utility Bills: Sure, you use that cell phone and Internet connection constantly to conduct business, but writing off 100% of the bill might not be acceptable if you use your devices to conduct personal business after work. To avoid an audit, keep in mind that you should only be writing off the percentage of the bill that you use the device for business. For example, if you use your phone 12 hours a day for business, and then the rest of the time for other activities, you should only be deducting half of the bill.
By understanding tax audit red flags and working with a business tax attorney, you might be able to avoid scary investigations and penalties.
