Several factors can increase the likelihood of a company being selected for a tax audit. While some audits are random, most are triggered by specific red flags or patterns in tax filings. Here are the most common triggers:
1. Unreported or Misreported Income
Failing to report all taxable income, discrepancies between reported income and third-party forms (like W-2s or 1099s), or rounding/averaging income figures can prompt an audit.
2. Disproportionate or Excessive Deductions
Claiming deductions that are unusually large or disproportionate to your reported income (such as high charitable donations, travel, or entertainment expenses) will often draw scrutiny.
3. Repeated Business Losses
Reporting business losses year after year, especially for small businesses or sole proprietorships, can make the IRS question whether the business is a legitimate for-profit enterprise or a hobby.
4. Large or Unusual Business Expenses
Excessive expenses, especially if they fluctuate significantly from year to year or are not typical for your industry, can be a red flag.
5. High Income or Assets
Businesses with higher income or substantial assets are audited more frequently, as the potential tax dollars at stake are greater.
6. Cash-Intensive Businesses
Businesses that handle large amounts of cash (such as restaurants or salons) are more likely to be audited due to the increased risk of underreporting income.
7. Employee Misclassification
Misclassifying employees as independent contractors to avoid payroll taxes is a common audit trigger.
8. Prior Audits or Audit Liabilities
A history of previous audits, especially if they resulted in significant liabilities, increases the chance of future audits.
9. Math Errors or Typos
Simple mistakes, such as math errors or typos on tax returns, can prompt additional scrutiny and potentially trigger an audit.
10. Large Refund Requests
Requesting substantial refunds, especially for sales and use tax, may trigger a review or audit, depending on the state and circumstances.
11. Whistleblower Tips or Referrals
Audits can also be triggered by tips from disgruntled employees, customers, or suppliers who report potential tax noncompliance.
12. Random Selection
Some audits are purely random, as the IRS uses statistical formulas and sampling to select returns for review.
Summary Table: Major Audit Triggers
| Trigger Event | Description |
| Unreported/Misreported Income | Discrepancies or omissions in reported income |
| Excessive/Disproportionate Deductions | Deductions are unusually large relative to income |
| Repeated Business Losses | Multiple years of losses, questioning business legitimacy |
| High Income/Assets | Higher earnings or assets increase audit likelihood |
| Large/Unusual Expenses | Expenses that are excessive or atypical for the business |
| Cash-Intensive Operations | Businesses with significant cash transactions |
| Employee Misclassification | Treating employees as contractors to avoid payroll taxes |
| Prior Audit History | Previous audits, especially with large liabilities |
| Math Errors or Typos | Calculation or data entry mistakes |
| Large Refund Requests | Significant refund claims, especially for sales/use tax |
| Whistleblower Tips | Reports from external parties |
| Random Selection | Randomized IRS or state selection |
How a Company Can Reduce the Likelihood of Being Audited
Companies can take several proactive steps to lower their risk of a tax audit. The following best practices, supported by expert sources, can help minimize audit triggers and demonstrate compliance if ever reviewed:
1. Ensure Accuracy and Consistency in Tax Filings
Double-check all figures and ensure that reported income, deductions, and credits are accurate and consistent across all forms. Errors, omissions, or inconsistencies are common audit triggers.
2. Maintain Thorough and Organized Records
Keep detailed documentation for all business expenses, income, deductions, and credits. This includes receipts, contracts, mileage logs, and bank statements. Good recordkeeping not only supports your claims if audited but also helps prevent mistakes in the first place.
3. Be Cautious with Deductions and Expenses
Only claim deductions that are legitimate, ordinary, and necessary for your business. Avoid excessive or disproportionate deductions relative to your income and be prepared to substantiate any claims with proper documentation.
4. Avoid Cash-Intensive Practices Without Documentation
If your business handles a lot of cash, ensure you document all transactions and reconcile them regularly. Implementing point-of-sale systems and depositing all cash income can help demonstrate transparency and accuracy.
5. File and Pay Taxes on Time
Missing deadlines for filing returns or making payments can draw unwanted attention. Always submit your tax forms and payments promptly to avoid raising red flags.
6. Stay Within Industry Norms
Reporting figures that are significantly outside the norms for your industry (such as unusually low revenue or high expenses) can trigger scrutiny. Benchmark your business against industry standards when possible.
7. Properly Classify Workers
Ensure employees and independent contractors are correctly classified according to IRS guidelines. Misclassification is a frequent audit trigger, so review arrangements carefully and maintain supporting documentation.
8. Respond Promptly to IRS Notices
If you receive any correspondence from the IRS, address it quickly and thoroughly. Ignoring notices can escalate issues and increase the risk of an audit.
9. Use Reliable Accounting and Tax Software
Employing reputable accounting software helps maintain accurate books and minimizes human error, further reducing audit risk.
10. Seek Professional Guidance
Work with experienced tax professionals or CPAs who understand audit risks and compliance requirements. They can review your filings, advise on questionable deductions, and help implement best practices for tax reporting.
By following these strategies-focusing on accuracy, documentation, timely compliance, and professional support-companies can significantly reduce their likelihood of being audited and be well-prepared in the event one occurs.