IRS Audit Red Flags
Ok. It’s here. A blog post about the dreaded A word – audits.
Every entrepreneur I’ve spoken to has been worried about being audited, but they also kind of assume it won’t happen to them. And statistically, they’d be right (I’ll get into actual stats a little further on).
Audits are dull, they’re tedious, and they’re just plain NO FUN. But as long as you have all your ducks in a row, if you ever did get audited, you’d be fine (if yawning a lot).
So, yes. The chances of actually having Uncle Sam come a-knockin’ is low – but there are some major red flags that could trigger a visit…
I want to give you a breakdown of some things you should be doing to stop those red flags being raised.
1. Claim all of your income
I see a lot of people get tripped up here, typically when revenue is coming through a merchant like Stripe. The mistake I see is that people record their income as what actually appeared in their bank account – not in their processor.
If you received $5 from the sale of a product, but Stripe took their $.50 fee before sending it to your bank, come tax time your numbers won’t match up.
YOU would claim just $4.50 as income. THEY would file a 1099 stating that you actually received $5 from the customer. And the IRS would raise their eyebrows…
They simple fix to avoid this particular auditing red-flag is to claim every payment a client makes as your income, and record the Stripe/Paypal/etc fees as an expense on your profit and loss.
2. Use Actual Numbers
I get it. Actual numbers aren’t neat and pretty. But I beg of you – do not round up your figures when filing your taxes! The amount in your bank account is never a series of neatly zero-ended numbers, so why should your income statement be?
Uncle Sam wants to know every single penny that you made, so rounding up your numbers will definitely not sit well with the IRS – and will likely trigger an audit. Besides, rounding UP also means you’ll be overpaying on taxes. Twice the reason not to do it!
3. Categorize Expenses Accurately
You know that, typically, your expenses fall into the category of marketing, office expenses, inventory… but sometimes there’s that thing that just doesn’t sit in one of those. We tend to categorize that as miscellaneous or other.
The problem here is: The higher this ‘other’ expense amount, the more shady it’s going to look to the IRS. If you were going to hide any dodgy dealings, they’d be in this miscellaneous category, right? Too much of those expenses and you’re being audited, my friend!
The way to fix this is to look at everything you’ve recorded as miscellaneous and see if there’s a more appropriate category it could go in. And if not – is it really an expense you should be claiming for your business?
4. If it makes sense to your business, form a corporation
If you’re an LLC, you can elect to be taxed as an S-Corp. You also have the option to form a C-Corp. Now, this blog isn’t about the differences and the pros and cons of this, but the way you’re taxed can change your chances of being audited.
Hire a professional to help you decide which (if any) corporation is best for your company – and make sure to watch my video training on YouTube to find out more about the statistics of each type getting audited.
One thing I do want you to note is that the chances of getting audited as a sole proprietor or LLC is around 2.4%, which is higher than the others. But that’s still a really, really low chance!
5. Lower Profit Margins mean Higher Chances of Auditing
You’re in business to make money, right? So if you’re reporting expenses as a high percentage of your income, this is going to make Uncle Sam ask some questions.
He will want to know why you’re running a business at such a low profit, especially since you’re not a non-profit organization.
If your business expenses are more than 48% of your income, your chances of being audited will increase. That doesn’t mean you should deny any legitimate expenses for your business; you should absolutely claim them! I just want you to know where that threshold lies…
6. If you’re an S-Corp, you need to take a reasonable salary
If you’ve decided to run your company as an S-Corp, it’s a legal requirement that you take what is considered a reasonable salary via payroll. This means that your taxes are being withheld, and the IRS can see you’re not trying to avoid them!
I know that the thought of being audited can bring a lot of stress into your life, both business and personal. I just hope that you’re able to relax knowing that the statistics of getting audited are low, and that there are some simple things you can do to avoid raising any red flags!
As always, if you have any questions around this, or any other money topic, shoot me a message over on Instagram and I’ll be happy to help!