The thought of an audit looms for many small business owners at tax time. The idea of an audit is frightening and even an audit with a favorable outcome is one that many of us can do without. The good news is that an audit where an entire return is examined is much rarer than in the past. When businesses do get audited, it's usually because something questionable on the return has caught the attention of the IRS. That's a situation that is often avoidable if you run your business cleanly and keep very good records.
Good records are critical for filing a return that's accurate, well-organized and not likely to raise red flags. Unfortunately, many small businesses are so busy taking care of customers that they simply lose track and don't keep good records. The IRS looks for unusual things and will look at the returns from prior years to determine a pattern. They look at your income and expenses in the context of what your company does or the particular industry, selecting specific categories looking for anything unreasonable for that type of business or large dollar amounts. Large amounts of entertainment expenses, bad debts or miscellaneous expenses send up those red flags.
A well organized return is important. Even a legitimate expense can trigger an unnecessary audit if it's not properly categorized. Unusual circumstances behind a particular entry on your return should include a letter of explanation.
It's not a matter of avoiding the audit - sometimes questions are inevitable. What's really important is to make sure your records and documentation are solid, your accounting practices are precise, and your payroll is being reported correctly.
