As 2019 comes to an end, businesses of all sizes face a yearly challenge: taxes. For startups, this can be a trying time. Small business and startups taxes are complicated, especially if you’re new to your industry, but it’s important to make sure all of your ducks are in a row. If you don’t avoid these common IRS audit triggers, you might find yourself under special scrutiny.
Audits are motions released by the IRS that indicate that they suspect you’ve filed your taxes incorrectly. In all cases, an audit will be released to a party that the IRS thinks has underpaid its taxes.So as you’re filing your startup’s taxes this year, keep an eye out for some easy mistakes to avoid. So long as you’re careful with your math and diligent with your paperwork, you should be able to make it through the year without any trouble.
Beware of State Audits
While it makes sense to be wary of the IRS, it’s important to know that a substantial number of tax audits actually come from state audit departments reconciling sales tax figures. The easiest error here is failing to charge the appropriate sales tax when doing business online, something that states are paying a lot more attention to. If you’re doing business in a state with sales tax, sell, anything, or provide services in a state that does, you’re going to want to make sure that you’re your due diligence when it comes to sales taxes.
Not sure what the rules are about sales tax in your state or the places you do business? Be sure to check out our sales tax nexus article.
Claiming Repeated Business Losses
This can be an especially tricky problem in the startup world, where you might expect to operate for a number of years without turning a profit. While this, in and of itself, isn’t enough to trigger an audit, it can draw the attention of the IRS. Make sure that if you are planning to claim losses for more than one year in a row, that you’re ensuring you have the documentation to prove that your business has a path to profitability and isn’t a hobby disguised as a legitimate enterprise.
Operating a Business in a High-Risk Industry
While all startups are high risk, if you happen to be working in an industry that the government or financial institutions categorize as “high-risk”, you’re more likely to receive an audit. There are a lot of high-risk industries, but the ones that draw the most negative attention for violations like tax non-compliance and being cash intensive tend to be retail and restaurants, but also includes businesses like electronic funds transfer services, auto dealers and some NGOs.
Frustratingly, you can sometimes be audited simply for doing business with someone in a high-risk industry. If you’re dealing with any of the above industries on a regular basis, make sure you are on top of your bookkeeping, just in case.
Avoid Large Cash Transactions
Less relevant for most startups, it’s still important to be aware of the right procedures and dangers of dealing with large volumes of cash. The businesses that tend to get dinged for this are usually retail or food service, so if your business model involves any brick-and-mortar locations, be aware of how you manage larger transactions.
Cash transactions have less of a digital and physical footprint than card-based transactions. As a result, the IRS won’t know where the money in question came from, how you used it, or where it went. Ensure that you’re closing your books correctly around revenue recognition, sales and payroll taxes, claiming the right credits when applicable, ensuring that there are digital records of sales and services.
Be aware of what might draw unwanted attention. Depending on the circumstances, unemployment claims, worker’s compensation, payroll disputes, or other industry-specific issues often involve a close look at the financials of a given company, which can then lead auditors to take a closer look.
Issues That Arise During a Different Audit
Another pitfall of running any sort of business is that you can end up receiving extra attention for matters entirely unrelated to your tax compliance if you’re not careful. One circumstance that often triggers an IRS audit are compliance issues that are uncovered during an entirely separate audit or investigation.
Taxes are rarely fun, no matter what your field is. That said, you’re going to want to be careful when you file for a startup. There are certain rules you’re going to need to follow. Mistakes or missteps like those listed above may cause the IRS to look into your finances more closely, damaging your financial reputation as a result.
If you have any doubts about your taxes, you can reach out to a professional to make sure you’re in line with applicable legislation. If it helps you avoid an IRS audit, it’s worth the consideration.