IRS Audit Triggers: Operating a Cash Business & More

IRS Audit Triggers—and How to Avoid Them

You have a lot to deal with to keep your company operating. One thing you don’t want to have to handle? An IRS audit. While some audits happen randomly, others trigger from red flags in your records. What are these IRS audit triggers, you ask?

There are common red flags that could trigger an audit, like claiming a lot of business deductions and operating a cash-only business. Read on to learn what causes the IRS to audit you and learn tips to avoid common audit triggers. 

Common IRS audit triggers 

During an audit, the IRS reviews your accounting records for correct financial information. If the IRS finds inconsistencies, you could face penalties and fines. So, what triggers an IRS audit?

The following are common IRS audit triggers that could make your business look suspicious to the IRS:

IRS Audit Triggers: Missing tax deadlines, Claiming a lot of business expenses, Claiming 100% business purposes on your vehicle, Incorrectly claiming the home office deduction, Making simple errors, Claiming too many charitable donations, Operating a cash business, Claiming a hobby as a business

1. Missing tax deadlines

The IRS notices when you file your taxes late—or fail to file. So, you must send tax returns and payments to the IRS by their due dates.

Missing filing deadlines can make the IRS think your financial records are disorganized. Disorganized records often contain errors, which would show up on your tax return. The IRS could audit your financial records to check for discrepancies.

How to avoid this IRS audit trigger 

Avoid an IRS audit by filing all your tax returns and remitting payments on time. 

Remember, you are responsible for more than just your yearly business tax return. For example, you may need to keep on top of deadlines for things like:

  • Employer tax returns 
  • Estimated taxes

Mark every tax deadline you need to meet on a calendar. Check the calendar regularly for a reminder of your IRS deadlines. 

Complete all the sections on each tax form you fill out. Also, make sure you pay the IRS the correct amount of taxes due.

2. Claiming a lot of business expenses

The IRS allows you to deduct company purchases on your business tax return. But, the items must meet certain qualifications set by the IRS. If the item doesn’t meet the IRS’s criteria, you cannot claim the business expense deduction.

You cannot claim an expense deduction for an item that is also for personal use. You must use the item solely for your company to write off the expense.

How to avoid this IRS audit trigger 

To avoid an IRS audit, be sure the purchase follows the IRS’s rules for a business expense deduction.

You can claim an item as a business expense if it’s:

  • Ordinary to your line of work
  • Necessary to run your business

If the item doesn’t meet the IRS’s qualifications, don’t deduct it. Be sure you can prove that the item is used for business purposes, not personal use.

3. Claiming 100% business purposes on your vehicle

You can deduct expenses made on the business use of your vehicle. But, claiming 100% business use of a vehicle looks suspicious. You probably use the vehicle for personal and business purposes.

For example, you might use the vehicle to commute between your home and your business. Your commute to and from work is not tax deductible. Unless you leave your vehicle at the business and solely use it for qualifying reasons, you can’t deduct all of its expenses.

How to avoid this IRS audit trigger 

You need to follow the rules for business use of a vehicle to deduct the expense on your tax return.

You must use the vehicle for business purposes to deduct the expense. Examples of valid business vehicle deductions include driving: 

  • From one business to another business
  • From your business to meet a client
  • To a business-related conference
  • From your business to a business supply store or the bank

To avoid an IRS audit, do not claim the vehicle as 100% business use. Instead, only claim the amount of expenses used solely for business purposes.

4. Incorrectly claiming the home office deduction

Do you complete work for your business from home? You might be eligible for the home office deduction.

To deduct home office expenses, you can use the simplified option to deduct $5 per square foot of your home office (up to 300 square feet).

Or, you can use the regular method to deduct actual home office expenses (including the business portion of expenses like mortgage interest, real estate taxes, homeowners insurance, and utilities). 

Claiming too much of your home for business may trigger an IRS audit. You cannot deduct personal expenses from your business tax return. If you use your home office for personal purposes, you cannot claim the deduction. Keep thorough accounting records to prove the expenses were for business purposes.

How to avoid this IRS audit trigger 

You must follow specific rules set by the IRS to deduct home office expenses. Make sure you meet these qualifications before claiming the home office deduction:

  • You use the space regularly and exclusively for your business
  • Your home office is the primary space you conduct business

You may want to check with your accountant before claiming the home office deduction. A professional can check that you correctly write off home office expenses.

5. Making simple errors

Nobody is perfect, and mistakes happen. But, errors on your business tax return could raise a red flag. By making an entry or mathematical mistake on your tax return, you could trigger an IRS audit.

For example, reporting an incorrect digit on a return can cause an IRS audit. You might write down a seven instead of a one. Or, maybe you forget a zero on a figure.

Other mistakes include mathematical errors. If your total figures do not add up, you might get audited.

How to avoid this IRS audit trigger 

Double-check the entries you make in your accounting books. Make sure to enter each figure correctly. And, have records supporting the numbers you report on your tax return. Check that you included everything on the return.

Also, be careful when reporting figures on your business tax return. Use a recordkeeping system, like accounting software, that makes it easy to record and track your financial transactions.

6. Claiming too many charitable donations

If your business made a charitable donation, you could claim its worth on your business tax return. The donation can be cash or property you gave to a qualified charitable organization. 

If you donate to an organization that doesn’t qualify, don’t claim the deduction. You must follow certain rules made by the IRS.

How to avoid this IRS audit trigger 

When you make charitable donations, be sure to:

  • Only claim deductions to qualifying nonprofits (use the IRS search tool for help)
  • Know what you can and can’t deduct (e.g., you can’t deduct the value of your time)
  • Only deduct up to the charitable donation deduction limit
  • Understand the fair market value of the items you donate
  • Record donations in your accounting books

7. Operating a cash business

If you run your business as a cash-only operation, the IRS is more likely to audit you. Businesses that deal heavily in cash are more likely to underreport income.

It can be difficult to keep track of cash transactions for an all-cash business. With checking and credit transactions, you receive a bank statement detailing each entry. But with cash transactions, you do not have a bank statement that shows each entry.

How to avoid this IRS audit trigger 

Whether you run a cash business or not, you need detailed and accurate financial reports. And if you do operate a cash business, you won’t have a bank statement detailing your transactions, so you’ll need to track cash transactions—diligently. Use a point of sale system that tracks transactions and saves register tapes to organize cash transactions. You must record every cash transaction for your company in your books, no matter how small.

Using online accounting software helps you keep track of cash transactions. You simply enter each transaction into the program. The software stores transactions, produces reports, and more.

8. Claiming a hobby as a business

Think you have a business, but it’s really a hobby? If that’s the case, you may try to take advantage of business tax incentives you don’t qualify for. 

Businesses can deduct expenses, while hobbies can’t. And if you deduct business expenses when you actually have a hobby, you could trigger an IRS audit. 

How to avoid this IRS audit trigger 

Know the difference between a business vs. hobby. A business operates to make a profit, while a hobby operates for sport or recreation (not to make a profit). 

Use the IRS nine-part test to determine if you have a hobby or business on your hands. For example, the test asks questions like whether you maintain accurate books and depend on income from the activity for your livelihood. 

Looking for an easier way to manage your books? With Patriot’s online accounting, you can track your expenses and income, record payments, automatically import bank transactions, and so much more. See it in action with our interactive video!

This is not intended as legal advice; for more information, please click here.

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