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How To Pass A Small Business Tax Audit: The Definitive Guide

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As a business owner, you may have thought about what it would be like to have your company’s records audited. The most important factor is accurately and truthfully presenting all your financial information.

Submitting accurate and honest tax returns to the IRS can help you avoid an audit. The IRS applies an automated scoring system, the Discriminant Index Function (DIF), to all returns. The higher the DIF, the more likely your return will be investigated. The IRS, however, does not reveal the exact methodology of DIF. Factors such as deductions that exceed reported income can lead to an increase in your DIF score.

This article will provide some essential tips and advice for avoiding red flags. 

What exactly is an IRS tax audit for businesses?

When you file your business taxes, you give the IRS detailed information about your company’s cash flow. It includes total income, costs, and any deductions you claim for the previous tax year. If the IRS believes you made a mistake on your business’s return, they will conduct an audit. They will check that everything was correctly reported. IRS auditors have three years to request an audit from the date you filed your tax returns. There are three ways to conduct an audit: by mail, in person at an IRS office, or in person at your business. A tax agent from the IRS will review your financial records for each method. They will look for any discrepancies in your return. They will also question you about the financial records of your company. After the IRS audit, you must address the issues or file an appeal with the IRS Office of Appeals within 30 days.

When do audits take place?

The IRS chooses an audit subject using a “statistical formula.”  It depends on a series of norms: “audits of a statistically valid random sample of returns, as a part of the IRS’s National Research Program.” The IRS also examines when returns are likely to “involve issues or transactions with other taxpayers like business partners or investors whose returns were chosen for audit.” 

Ways to beat small business tax audits:

Moreover, it’s crucial to maintain payroll records using a paystub generator and other automated software. Now let’s look into a few ways to beat small business tax audits.

Examine records for potential audit red flags On-time submission
Don’t confuse business & personal record Seek professional help

Examine your records for audit red flags:

To avoid an audit, you must conduct thorough research. It’s pretty simple to do. Could you look over your income records? Did you enter the correct value? The IRS compares your income to other tax records. Also, make sure that you have reported all your income. Finally, double-check your business expenditure—especially meal and entertainment expenses, which are a major IRS red flag. Sloppy returns raise red flags. Using tax preparation software improves the appearance of your return. It helps you avoid mistakes. Accuracy begins with keeping a good record. If the IRS questions anything on your return, you must prove it correct. One method for keeping accurate records is to use good business accounting software.

On-Time Submission:

The IRS does have rules governing what happens when you file a return late. While the initial penalty may not appear too severe, late filing is a trigger. You increase your chances of getting audited if you consistently file late returns. Prepare accurate records on time to avoid the possibility. Hiring someone is worth it if you need more time or skill set to do your accounting. The best way to ensure that you file on time is to make preparing returns quick and simple. A late tax return automatically captures the IRS’s interest. To avoid an internal business audit, could you submit the documents on time or file for an extension well in advance? While taxes will still be due on the same date, you will have extra time to prepare all your paperwork. It will help you to avoid becoming an audit-risk business.

Do not combine personal and business deductions:

The IRS is looking for business owners who try to deduct personal travel or other costs from their taxes. You can only deduce expenses related to your business. Could you ensure you understand what you can conclude as a part of business entertainment costs? Avoiding mileage deductions for the personal use of a vehicle is another IRS audit red flag. Determining the appropriateness of tax deductions can take time, especially if the small business owner is a sole owner. An audit will immediately notice errors in distributing personal and business tax deductions. Be as honest and detailed as possible to avoid becoming an audit-risk business.

Seek professional help:

Getting a tax lawyer, accountant, or enrolled agent to represent you might be a good idea. It will help you feel more supported. You can remove yourself, your emotions, and your fears from the equation altogether. Also, the IRS will need to contact the agent on your behalf. To begin, file Form 2848, “Power of Attorney and Declaration of Representative,” with the IRS. But, before, do some research on the tax professional. See if he has the qualifications and experience to handle your audit case. Inquire whether he has ever represented others before the IRS and how many points he has won. Make sure you understand the fees for representation during an audit. Also, talk to other clients to learn about their experiences with your designated tax professional.


Knowing what steps to take to ensure that your tax return is deemed acceptable by the IRS is paramount if you are one of the few businesses chosen to be audited. Tax audits are time consuming and costly and small business owners would rather use their time and resources to increase their profits. After conducting research and analysis, this article presents several tips that can help reduce the chance of being audited by the IRS.

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