How to Prevent an IRS Audit of Your Business

You need to have your data set and most small business owners don't put enough time to both tracking their expenses and keeping business expenses separate from personal. That's a key flag for the IRS. Second, you don't always remember to track all of your revenue. They might accidentally report net revenue where the IRS is looking for gross revenue. Those types of things would be potential flags for the IRS.

Is it smart for small-business owners to do their business taxes themselves?

Aldrich: Most small businesses don't have enough take-home income to hire a separate bookkeeper. Most small business owners are sole proprietors and working on their own day in and day out. It might be more than these small businesses think they need. You even have the case where you have a professional who is helping you as an adviser on the side. The small business owners still have to provide the data and the raw input for returns. When push comes to shove many don't prioritize making sure their data is complete and fully accurate.

If you get notified that your business will be audited, what is the first thing you should do?

Aldrich: As a precursor to that, as the year is going along and you have expenses, make sure you're keeping those as back-up data. If you claim a home office as a deduction, take pictures of your home office, so that later on if there is an audit, you can say here are the pictures showing that.

The second piece is meet your tax deadlines. One of the things that is a critical factor for raising audit risk is not filing on time.

These are things you can do before. If you do get a letter ... Be calm. Collect the information the IRS is seeking. Get prepared by reminding yourself where the numbers came from, so that you can send back a thoughtful reply. Sometimes it's just an "oops" moment. You may have just put a number in the wrong place.

What's the worst case scenario in an audit?

Aldrich: If you have underreported income, the IRS is going to ask you to pay tax on that income. Depending on how much, you'll potentially have to pay penalties and maybe interest. The thing to do there is be transparent about what you can pay if you don't have the money. They want folks to stay in business so they can collect taxes owed.

Is the IRS willing to work with people on payment plans?

Aldrich: They absolutely do that. That is something you should definitely ask about.