Getting audited by the IRS can be a little scary—not to mention frustrating. In order to avoid being singled-out, do everything you can to avoid making the following mistakesthat the IRS deems to be red flags:
- Having more contractors than employees
- Claiming too many “miscellaneous” deductions
- Extremely high executive compensation
- An inconsistent social media profile
- Family members on your payroll
- Reporting your net income rather than gross revenue
- Excessive home-office deductions
- Missing any tax-related deadlines
- Using the wrong accounting method
- Self-employed travel and entertainment
Audits are primarily unpleasant because they always require you to do more work, such as providing additional documentation of your finances and expenses (i.e. proof of deductions). In other cases, you’ll actually need to visit your local IRS office and show them specific information, such as the books and records of your business, or personal bank statements and receipts.
If they conclude you’ve made mistakes, then you will have to pay the proper taxes, pluspenalties and interest.
The two most common accuracy-related penalties are the "substantial understatement" penalty and the "negligence or disregard of the rules or regulations" penalty. These penalties are calculated as a flat 20% of the net understatement of tax.
You may have to pay a penalty of $5,000 if you file a frivolous tax return or other frivolous submissions. A frivolous tax return is one that does not include enough information to figure the correct tax, or one that contains information clearly showing that the tax you reported is substantially incorrect.
These penalty fees—as well as the laborious paperwork it will take to identify and correct them—should be more than enough reason to keep your books in order well in advance.
For the self-employed, one of the best things you can do is e-file. Using online software could reduce your chance of an audit, since all of your numbers (and errors) will be checked by the system before submitting. E-filing also reduces the risk of being flagged for illegible or unclear handwriting.
Some e-filing services also offer the added protection of Audit Defense, which provides you with professional representation in the case of an audit—meaning you’ll never have to speak to the IRS if you don’t want to.
Of course, the best way to avoid running into any tax problems in the first place is to keep all of your finances organized with business management software. Being well organized is being well prepared in the unlikely event you get audited. And the more organized your books are, the faster you will be able to provide the IRS with any information they ask for.
When it comes to tax audits, the easier you make the process for everyone involved, the better!