Sole proprietors are at increased risk of being audited by the IRS

Mistakes Can Trigger IRS Tax Audits observes that we all make mistakes from time to time, whether it is forgetting an anniversary or inadvertently leaving your wallet at the gym or a restaurant. Some mistakes can be more costly than others. For sole proprietors and other small business owners, tax mistakes could result in triggering an IRS tax audit and, potentially, in having to pay costly fees and tax penalties.

Sole Proprietors and Tax Audits

YFS magazine notes that small businesses are often a go-to-target for the IRS. There is a suspicion that many small business owners are under-reporting their business income. As a result, sole proprietors or single-member LLCs are much more likely to be audited than W-2 wage earners. In part, the IRS is targeting these taxpayers for increased scrutiny as part of a general effort to reduce the federal deficit. Business Journals notes that accountants tend to believe that sole proprietors are 25 percent more likely than other business owners to be audited by the IRS and the California Franchise Tax Board.

The Work at Home Moms website observes that taking business deductions can be a trap for sole proprietors. In this regard, WAHM advises that new sole proprietors need to be wary of “shady small business tax advice” when they start a business. On one hand, a sole proprietor needs to take advantage of all tax deductions legitimately available since the failure to do so can result in leaving significant amounts of money on the table that could be reinvested in their business. However, trying to bend the tax deduction rules will be viewed as tax evasion. In a worse case scenario, breaking the tax laws could cause you to lose your business and even your personal freedom.

To avoid problems with Uncle Sam, one should engage in good record keeping practices which substantiate deductions. The WAHM website notes that, unfortunately, record keeping is a task that many sole proprietors try to avoid and do not take seriously. A business owner who can substantiate his or her deductions with documentation has no reason to fear an IRS tax audit.

Avoiding scrutiny

According to YFS magazine, there is no sure-fire way to avoid a tax audit. However, steps can be taken which can help lower a sole proprietor’s chances of being audited. First, avoid excessive tax deductions and take extra steps to “have your ducks in a row” when it comes to impeccable documentation. Second, avoid submitting incomplete tax returns. Incomplete tax returns tend to raise red flags since the IRS is going to want to know if your omissions or mistakes were deliberate.

Third, try to submit your tax returns on time and avoid amended returns. Amended returns can raise yet another red flag with the IRS. Fourth, avoid entering all round numbers on your return. If it looks you are estimating business figures-possibly down rather than up-IRS agents will start to wonder what your books really look like. Fifth, do not cobble together a return in a sloppy fashion by making mistakes such as inadvertently transposing numbers. While math errors may be an honest mistake, your return will stand out for extra scrutiny.

Seeking legal counsel

If you are a new sole proprietor or small business owner, you should consult with a California attorney experienced in tax planning. Good tax planning advice can minimize your tax liability while helping keep you out of trouble with the IRS.