With each passing year, companies go through the process of filing an end-of-year return and face the foreboding possibility of being audited. Corporate tax audits are unfortunately a source of worry and apprehension for business owners, and they inevitably entail additional accounting expenses that impact a company’s bottom line.
It’s impossible to entirely avoid an audit, but staying informed by knowing what puts up a red flag in the eyes of the IRS can help companies avoid the audit hassle and minimize their accounting expenses. Misconceptions run rampant regarding corporate audits and how they can be avoided. These misconceptions sometimes cause companies to waste money on ineffective efforts to avoid audit. The following are a few of these common misconceptions about corporate audits:
Misconception 1: Companies can avoid audits by overpaying.
If you overpay the IRS when handling your corporate taxes, you won’t in any way diminish your chances of being audited. The IRS is not going to make adjustments for you if you pay too much in one area and not enough in another. You’ll simply be audited and have to put the time, effort, and money into resolving the issue yourself. Overpaying simply makes it likely that you’ll lose the extra money.
When it comes to filing a corporate tax return, accuracy is the most important thing. The easiest way to be accurate is to carefully maintain your records and receipts throughout the year.
Misconception 2: There is only one type of business tax audit.
Some business owners are under the impression that the only type of audit is an audit conducted because the IRS sees some inaccuracy in a company’s return.
In fact, there are three different types of corporate income tax return audits: a correspondence audit, a field audit, and a random audit. A correspondence audit is usually conducted because the IRS detects a mathematical error in the audit submitted by a company. A field audit is a more detailed audit that results if the IRS feels that a company has a suspiciously high number of write-offs. The third type of audit is a random audit. Both the IRS and the CRA conduct random audits every year to encourage accuracy when returns are filed.
Companies shouldn’t invest too much time and energy into avoiding audits because they are always at risk of experiencing a random audit even if they do everything right.
Misconception 3: The IRS is not going to be familiar enough with my industry to understand appropriate deductions and expenses.
When the IRS processes company returns, these returns are compared to the returns of other companies operating in the same industry and in the same area.
Because the IRS does this comparative processing, it becomes familiar with what deductions and expenses are appropriate to a given company. Unfamiliar or suspicious expenses are therefore likely to stand out, so companies should consider how expenses claimed are likely to compare with the expenses of competitors when attempting to minimize audit chances.
Misconception 4: Any correspondence from the IRS means I’m being audited.
If your company receives correspondence from the IRS, it’s important to analyze the correspondence carefully. Assuming that an audit is coming and investing time and effort into preparing receipts and spending reports could prove to be useless if the issue can be resolved with a brief response from your accountant.
Correspondence from the IRS could be received for a variety of reasons. It could indicate simply that a return was incomplete or that a calculation discrepancy was noticed.
Misconception 5: Sole proprietorships and corporations have equal chances of being audited.
Being incorporated makes you eligible for some deductions for which sole proprietorships are not eligible. Many business owners therefore assume that it also leaves you more open to being audited. However, this is not true.
In fact, corporations tend to be less likely to be audited. Statistics show that sole proprietorships are actually three times more likely to experience audits than corporations.
Misconception 6: I’m more likely to be audited business is financially strong.
One of the most significant red flags for corporate income tax audits is consecutive years of business loss. If you experience losses, you will be paying less in taxes. As such, the IRS will be getting less money and will be more suspicious that you are not reporting correctly on your return.