Surviving a small business tax audit

No matter how meticulous the records are kept, perhaps nothing strikes fear into the heart of a small business owner than an audit notice from the Internal Revenue Service. Although the process can be stressful, the following tips can help you avoid being audited, as well as help you deal with the tax audit process.

Avoiding an audit

Although every tax return filed can be subject to an audit, the IRS is more likely to choose to audit a small business if there are certain mistakes on the tax return. These tips can help you avoid the red flags that can trigger an audit:

  • Don't mix business and personal expenses. The IRS looks for instances where personal expenses are being claimed as business expenses. Experts recommend using a separate credit card for business expenses.
  • Report your full income. Many businesses unintentionally misrepresent their income by reporting their net income rather than their gross income.
  • Be careful with deductions. If you are claiming deductions that are unusual, be sure to provide a detailed description of the deduction on your tax return, so the IRS can easily verify it. The IRS routinely red flags deductions classified as "miscellaneous."
  • Timing is everything. If you are late on meeting IRS deadlines, it can make you appear disorganized and trigger an audit. File your 1099s and quarterly estimated tax statements on time.

Handling an audit

Even if your tax return is error-free, there is always the risk of an audit. However, these tips can help you get through the process:

  • Keep good records. The IRS can look at any records that were used to prepare your tax returns. If you go through your records and organize them in a logical way, it will help refresh your memory for the audit meeting.
  • Organize, organize, organize. Ensure that the records are neat and clear. Tax auditors will often give you the benefit of the doubt if a problem arises, if your records are clear. Conversely, the IRS punishes sloppy recordkeepers by digging deeper.
  • Anticipate any problems. Check your records ahead of time and ensure that documentation or tax law substantiates your income and deductions.

To document your income, deduction and expense, the tax auditor may ask you to produce the following documents:

  • Bank statements and receipts. If you paid cash for something, make a handwritten note to show the payments.
  • Credit card statements. Note that credit card statements will often not be sufficient to show the business nature of the expense-keep other documentation to prove this.
  • Business records. There is no legal requirement for a business to keep formal books, but the auditor is entitled to see any business records that are kept.

Consult an attorney

Tax law is complicated and changes every year. If your business is the subject of an IRS audit, contact an experienced tax attorney. An attorney can assist you with the audit process and ensure the best possible outcome.