There's no guaranteed way to avoid an audit, but there are some red flags you can avoid so you can reduce your chances of being audited by the IRS.
Until recently, your odds of having your small business tax return get audited were very low. Bloomberg cites IRS data indicating that only 140 partnership returns, out of 4 million total, were audited in 2018. That's very close to 0%.
The numbers were a little higher for S corporations, with 397, or .01%. However, in late 2020, the IRS announced it would be adding auditors to allow the agency to increase its audits by 50% in 2021, which means that your odds of being audited just went up.
These are the red flags you should avoid raising.
1. Don't report a loss.
"Never report a net annual loss for any business... especially a small loss," says Steven Jon Kaplan, CEO of True Contrarian Investments, LLC. "When the IRS sees a net business loss, it is practically begging to be audited. You are required to report all of your income, but you don't have to report all of your expenses, so leave out a few expenses if that results in a small net profit for the year."
Steven Terrigino, CPA, partner at The Bonadio Group says, "When a business you have ceases to make a profit, determine if it should be treated as a hobby."
2. Be specific about expenses.
"Whenever you have a choice between putting a particular expense in a general category or specifically listing it under 'Other Expenses,' always favor explicitly listing it," Kaplan advises. "The IRS might think you are trying to invent nonexistent expenses if you lump together advertising or travel, rather than itemizing each specific advertising or travel expenditure."
3. Provide more detail when needed.
Rather than assuming a potential auditor will understand why your travel expenses suddenly dropped by 100% in the past year, or why your online advertising expenses ballooned by 300%, complete additional paperwork and attach it to your return when you file to explain in detail what happened.
That way, if your return is triggered and gets in front of a human being, you've already answered many of the questions they'll have for you regarding the sudden changes.
4. Be on time.
Although some people believe that filing late, even with an extension, is a way to reduce your odds of an audit, Terrigino says, essentially, no.
"File on time and pay on time to create a history of compliance, including all ancillary returns (i.e. payroll and sales tax)," he says.
5. Avoid amending returns.
Or at least avoid doing it frequently, says Terrigino, which can also support your history of compliance.
6. Match up all your paperwork.
Since the IRS determines which accounts to audit based on discrepancies, "make sure all government-issued forms, such as 1099-INT, 1099-DIV, etc., match what you report on the tax return," Terrigino says. Your math needs to match.
7. Don't use the same numbers repeatedly.
Terrigino says, "Don't use the same numbers for deductions year after year, especially round numbers [unless it is an actual figure]."
Expenses are expected to change and if yours haven't, that could raise some red flags.
8. Don't take excessive deductions.
That means not overestimating the extent of your donations, not taking an excessive home office deduction, nor excessive deductions for meals and travel, says Terrigino.
These and other expenses like bad debt, casualty losses, and medical expenses are examined with extra care. Also, don't suddenly include a large number of deductions you've never taken before. That gets noticed.
9. Use Schedule C.
"Always report all small business earnings using Schedule C," says Kaplan. "Although there are other methods which may sometimes avoid paying part of your Medicare tax or have other advantages, they also greatly increase the likelihood of an audit." Schedule Cs are less likely to be audited, he says.
10. Don't leave questions blank.
Every question on the tax form should have an appropriate answer, even if that answer is $0. Make sure you've completed every line that's relevant. An unintentional oversight could get your return some extra attention you don't want.
Ultimately, it's important to understand that your odds of an audit are small. In general, businesses and individuals with earnings in the multiple millions of dollars are more likely to be audited. Just don't give the IRS a reason to want to take a closer look at your figures and you'll save yourself some time.