IRS audit's aren't fun. In addition to sleepless nights, they can be costly and time-consuming. The more you can do to keep your distance from the IRS the better off you are.

I have seen audits go on for years. In fact, I have a client who donated approximately $150,000 of private company stock to his church. He was legally allowed to take the deduction. The problem was, even though it was legal, it was still a "red flag." I told him that it might trigger an audit.

Well, unfortunately, I was right. Even though we were ultimately successful with the audit of the donation, it took years to resolve and opened up other areas of his tax situation to the IRS. It wasn't fun for me and it certainly wasn't fun for him.

The odds of any person or business being singled out for an audit by the IRS are relatively low. That said, there are some things that you can do that will lower your chances of being one of the unlucky ones selected each year. Let's take a look at three practical things you can do.

1. Don't be too aggressive.

Some of those selected for an audit are truly chosen at random. However, most are selected based on an IRS algorithm. The algorithm examines tax returns (including deductions) and singles out the ones that differ in significant ways from others in the same tax situation.

Business owners are at a greater risk of audit. The IRS has found that many taxpayers understate their income or overstate their deductions. While you should claim any deductions that you are clearly entitled to, you raise your risk if you are too aggressive.

For example, let's assume you have a small business with $10,000 of revenue. Let's also assume that you deduct a $5,000 cell phone bill and claim 20,000 business miles. This might look suspicious to the IRS. If your expenses and deduction categories appear reasonable you are more likely to fly under the radar.

2. Tie out your IRS documents.

You receive tax documents (W2s, 1099s, 1098s) for a reason. Make sure that they are all included in the proper location on your tax return and the numbers agree. In addition, using incorrect forms or not using all the required forms can cause you to be selected for audit. New business owners often overlook schedules they are required to use to report income and expenses.

Your business may file as a sole proprietorship (Schedule C), partnership (Form 1065), an S corporation (Form 1120-S) or a C corporation (Form 1120). Just make sure that you use the proper form. If you are confused, there is a good chance the IRS is confused as well.

3. Hire a CPA or tax professional (and not just at tax time).

This last piece of advice is often the most important. Simply following it can reduce your audit risk in many ways.

Make sure you consider hiring a CPA or tax professional to help you, and not just at crunch time two weeks before the tax deadline. Consulting with a tax professional throughout the year can lower your audit risk because he or she will be able to advise you of audit risks before you engage in them. A qualified tax professional will then also be better acquainted with your situation when tax season does roll around.  

Just like any other area of risk in your business, you need to consider your audit risk and how to mitigate it. For some business owners, an audit can be a nightmare. For others, it is simply a nuisance. Just make sure that you are aware of your audit risk before you file your taxes.

Published on: Feb 1, 2018
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