As promised, here is Part II of our tips for Schedule C filers and other small business owners on avoiding triggers that make an IRS audit likelier.

Unfortunately, there are no guarantees that the IRS will not audit you, as a business, even if you’ve been scrupulous.

However, there are some things small business owners can and should do to minimize the risk of an audit.

These include watching out for “red flags: which are likelier to trigger an IRS audit.

To avoid them, we strongly urge you to consult with your virtual/fractional CFO or other trusted business and tax advisor.

Additional common red flags are:

Recurring Business Losses

Any business can have a bad year, or more than one, and show a loss. You can be as savvy as the best of them, but there are always human factors, luck, market conditions, and other considerations in play.

But repeated business losses, year after year, may cause the IRS to question whether you’re running a real business or a hobby, by the IRS’ definitions, of course.

If you have repeated business losses for readily explained reasons – expansion undertaken over a few years, purchases of necessary new equipment, capital improvements, etc., document them in a narrative, highlighting the temporary nature of the losses. Include any new clients/customers who may have entered into agreements with you that have not yet ripened into cash receipts.

Do your best to mitigate and minimize your losses. A business that fails to show profitability after years may signal it’s time to cut those losses, but it also may not, depending on the facts and circumstances of your unique business.

But, again, detailed, supported, and well-maintained documentation is the best defense against an IRS audit offense.

As I often say, “proper prior planning prevents poor performance.” It’s also the best way to 1) avoid a tax audit, or 2) be prepared for one if the IRS insists.

“Excessive” Income

It seems horribly unfair, but while the IRS may raise an eyebrow — or an audit — in response to what they consider “excessive” business losses, they may also find “excessive” income or profit questionable.

As your business income rises, so too does your chance of an IRS audit. From their viewpoint, we can understand it — the profits are low-hanging fruit, and they have money to pay.

The IRS is, in fact, targeting the more profitable, whether businesses or individuals, having come under scrutiny for disproportionately targeting the less well-off.

So now they target the better-off to a greater degree.

Once again, detailed records, documentation, and written narratives outlining why your business has picked up so much are your friends.

It’s also a good idea to familiarize yourself with industry norms relating to business income and profitability. These provide helpful benchmarks and can clue you in to what might need more explanation than just the numbers.

Business Use of Vehicles

If you use a vehicle for business purposes, even your personal car, you are entitled to deduct certain expenses relating to the vehicle on your tax return.

But if you have only one car, do not make the mistake of saying its use is 100% business-related. The IRS will see this as a red flag.

We recommend you use the mileage rate for deductions — currently at $0.70 per mile — and keep records showing where and when you drove for each business trip. Parking fees and tolls are also perfectly proper tax deductions.

But keep the records handy in case the IRS asks. Any IRS “ask” is a demand.

If you have two vehicles, one dedicated to business purposes and one for personal use — congratulations, by the way — then you can deduct precise expenses for your business vehicle, including repairs and maintenance.

These and last week’s red flags are only examples — they are not a comprehensive list of things that might trigger IRS scrutiny or even an audit.

We invite you to consult with Rigby Financial Group’s expert virtual fractional CFOs. We can guide you through the best ways to protect yourself, so far as possible, against the threat of an IRS audit. The best solutions for you and your business should be custom-tailored, not off-the-rack.

Because one size never fits all, and at RFG, we celebrate your uniqueness! We are never looking to offer cookie-cutter solutions—every service we offer is custom-designed to meet the needs of your business, your goals, and your desires.

So, come to us to custom-tailor your business and tax planning. We offer more than that, of course – and adhere to the same philosophy in everything we do.

Rigby Financial Group is not about us – we are about you!

Please click here to email us directly. Let us know how we can help — that‘s what we are dedicated to and passionate about.

Until next time –

Peace,

Eric