The word “audit” elicits fear, not unlike that of the Salem witch trials. Although punishments are less brutal (thank goodness), the government isn’t afraid to set fire to your business. If the IRS decides to audit your company, your financials need to be in tip-top condition to avoid hefty penalties.
Audits aren’t just about investigating your integrity—even honest small business owners can fail. These financial investigations care little about ignorance and lots about meticulous records.
But fear not! There are simple steps you can take now to guarantee your small business passes with flying colors. Although an audit is very unlikely (about a 0.5% chance), it’s best to be prepared for the worst.
By taking these 6 steps now, you’ll be ready if the IRS knocks on your business’s door.
1. Keep Detailed Financial Records
Occasionally, the IRS audits businesses randomly. But more often than not, the IRS decides to audit businesses with suspicious tax returns. To make sure you’re honest and can prove it, keep detailed records of all your income, expenses, losses, and deductions.
The law requires you to keep these records for up to 3 years, but most tax professionals advise you to keep it for at least 7. If you’re using bookkeeping software like Sunrise, maintaining financial records is a breeze. Cloud bookkeeping software helps you keep always available, always up-to-date data on your financials.
So, if the IRS has questions, you’ll have easy-to-access answers.
While you’re at it, make sure to separate your personal expenses from your business expenses. Keep a separate bank account and credit card for your business. This practice will help you identify the appropriate transactions without any confusion.
2. Create Digital Copies of Your Receipts
If you’re using cloud bookkeeping software as we’ve suggested, uploading and organizing your receipts is simple. If you claimed deductions, you’re going to need itemized receipts to prove your purchase. No expense is too small—make it a habit to create a digital copy of every business receipt.
3. Lean on Your Accountant and Bookkeeper
Get in touch with the accountant or tax professional who performed your tax return. They should help compile the appropriate documents. Also, make sure your bookkeeper is present, too. They’ll be able to speak to the bookkeeping processes and help accelerate the audit.
Don’t have an accountant or bookkeeper? Consider hiring one. Keeping track of your financial records is hard work—even if you’re never audited, they’ll be well worth the price. And if the IRS does decide to audit you, you’ll be forever grateful you have help to lean on.
4. Be Transparent About Your Contractors
More small businesses are saving money by hiring freelance contractors instead of full-time employees. This approach saves the company from paying for benefits, paid-time-off, and other employee perks. But high expenses on multiple independent contractors trigger the IRS.
That doesn’t mean you shouldn’t use freelancers—it just means you need to make sure they qualify as independent contractors and not employees. The term you give them isn’t as important as the 3 factors the IRS considers: Behavioral Control, Financial Control, and Relationship of the Parties. Review the IRS’s guidelines to avoid misclassifying and receiving hefty penalties.
If you pay any contractor more than $600, you need to file a 1099 with the IRS. Make sure every contractor sends you a signed W-9 before you pay them.
5. Stay Up-to-Date on Regulations
Laws change, state and local taxes vary, and auditing rigor fluctuates. But the IRS won’t let you use that as an excuse. It’s your duty to stay current on all regulations and taxes. Stay compliant by verifying your tax settings are always up-to-date on the software you’re using.
6. Hit the Deadlines
Not too late, not too early—just right. File your tax return too early, and you’ll give the IRS plenty of time to review it meticulously. Even if you’re 100% honest, it’s best not to give the IRS extra time to dig for errors.
It’s more important, though, to avoid late filings. If you fail to file on time (or fail to file at all), the eye of the IRS will find you. Imagine Sauron’s eye finding Frodo whenever he puts on the One Ring—it’s just like that. Make sure to meet all of your important deadlines—not just the yearly tax return.
An IRS Audit Isn’t the End of the World
Usually. While an audit can be a major pain in the backside, it’s not an indictment. It’s an investigation.
By following these 6 steps, you can avoid IRS suspicion and stay on your merry way. If the IRS does audit your business, whether at random or due to suspicious behavior, you’ll be ready to survive unscathed. Don’t wait for the unwelcome letter from the IRS to land in your mailbox—start audit-proofing your business today.