No business owner or individual wants to deal with an IRS tax audit. As the year comes to a close, it’s a good time to review your financial records as you prepare to close out 2020 and file taxes early next year. Here are five things you can do to protect your business and possibly avoid an IRS audit.
1. Always report all income.
Not reporting all your income is a big red flag to the IRS. This is not just income you received and paid taxes on. Remember that not all organizations will issue you a 1099 if they paid you less than $600. However, the IRS still expects you to report that income on your tax return. You also need to report income received from brokerage accounts, rental property and distributions from a college savings account to pay tuition.
2. Properly classify all employees during payroll taxes.
If you’re a California business owner, the state Employment Development Department (EDD) frequently conducts what’s known as EDD audits to businesses that classify a worker as an independent contractor instead of an employee. This means the EDD can personally assess the business owner for “unpaid” payroll taxes because the EDD has determined that they believe these workers are actually employees. Make sure all your employees are classified correctly as you file payroll taxes.
3. Be strategic about the charitable donations you give.
Donating to charity is an important act of social responsibility and it does help lower your tax liability. However, donating too much money will raise a red flag to the IRS, especially if those donations are large compared with your income. You also need to make sure you file the IRS Form 8283 if you’ve made a non-cash donations such as vehicles or art (anything that is more than a $500 value).
4. Be honest and transparent with your business expenses.
If you own your own business or are a sole proprietor, you likely itemize and write off all your business expenses to decrease your tax liability. This is expected and you should continue to do so. That being said, the IRS looks for expenses that may fall just outside the typical business expenses. These include meals, entertainment, or travel that may be more than just business. Other business expenses that can cause the IRS to raise a red flag are writing off a vehicle and home office.
5. Use an experienced tax attorney or preparer.
The best way to possibly avoid an audit by the IRS (or the California EDD) is to work with an experienced tax preparer or tax attorney. There’s no way that you, as a business owner, can know exactly what will trigger the IRS to look more closely at your finances. But experienced tax attorneys and professionals are trained to know what to look for and how to avoid red flags. To avoid unnecessary time and money you may spend later, be proactive and seek out their advice before doing your taxes.
Nobody wants to deal with the IRS. Receiving a tax or payroll audit is a confusing and scary matter. Knowing what to expect and handling the request with a competent lawyer and tax attorney will help you navigate these murky waters.
Allison Soares is a partner and tax attorney at Vanst Law. Before starting her own practice, Soares was a partner at a tax law firm where she honed her skills handling a wide variety of tax and employment-related cases. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits.