Take this scenario: an entrepreneur assembles his financial paperwork and passes it off to an accountant, who completes the return and sends it back to the entrepreneur. He means to review it, but because it’s already mid-April and the return needs to get filed, he approves the return and submits it.
According to CPAs I spoke with, that scenario is far from hypothetical. In fact, it’s an all-too-common occurrence among entrepreneurs who, if audited, are responsible for the entire tax return.
While there isn’t necessarily much a small business owner can do to avoid being audited, there are steps that can make an audit less of a headache. Here are six:
Audit yourself first. When you have the chance to review the return, look it over before you sign it. If you sign the return, you are attesting to its accuracy, even if it was filed by a third party. “The IRS has the ability to match tax return data to statistical averages,” says Ken Stalcup of Somerset CPAs, a firm based in Indianapolis. “They will focus their collection efforts on returns falling outside the norms.”
Keep personal and business expenses separate. Maintain individual business and personal bank accounts and credit cards. Arguably one of the easiest tips to remember, it’s also one of the most common mistakes small business owners make.
Document all expenses. “You are required to keep all receipts and invoices as proof for both income and expense,” says Tiffany Powell of Sapphire Bookkeeping & Accounting. “Credit and bank statements do not qualify as proof something is a business expense.”
Understand your deductions. If you take a 100 percent home-office deduction, for example, you’re doing something wrong. This deduction is only valid as a percentage of your home (or apartment) that you use exclusively for work purposes, usually a small fraction of your living space. A similar rule applies to deductions for transportation, insurance, and entertainment.
Respect the auditor. This means meeting deadlines and remaining respectful, keeping in mind that some decisions might be subjective. Building a rapport with the auditor and your CPA can even expedite the process in some cases, saving you time and money.
Avoid filing a late return. Filing late is an audit red flag and puts you at a disadvantage from the start. According to Steve Hoffman, partner of The Ordinary Success Project, one common mistake entrepreneurs make on their taxes is assuming that an extension gives them extra time to pay. “It is only an extension of time to file, not to pay, and penalties can be assessed for not paying on time,” Hoffman says.