These best practices reduce audit risk, and give business owners peace of mind 

Few words strike more unease into a business owner than “IRS audit.” The thought alone can be stressful, imagining a deep dive into your financials and the potential for penalties.

Let’s be upfront: no business can be 100% audit-proof. Audits can be random, triggered by complex algorithms, or arise from factors outside your direct control. However, that doesn’t mean you’re powerless. The real goal isn’t to guarantee you’ll never be audited. It’s to drastically reduce your risk and ensure that if the IRS does come calling, the process is as smooth, quick, and penalty-free as possible.

This post outlines practical steps to build a more “audit-resistant” business, giving you greater peace of mind.

Why audits happen 

Understanding why audits occur can help you focus your efforts. Common triggers include:

• Random selection: Sometimes, it’s just the luck of the draw.
• Computer scores: IRS algorithms compare your return to others in your industry or flag significant changes and inconsistencies (like unusually large deductions compared to income).
• Document matching: If income reported by third parties (like 1099s) doesn’t match what you report, it raises a flag.
• Related audits: An audit of a business partner, supplier, or customer could lead to scrutiny of your transactions with them.
• IRS focus areas: The IRS sometimes targets specific industries or common areas of non-compliance.

Build your audit defense

You can significantly strengthen your business against audit risks by focusing on these five areas:

1. Clean books always

Problem: Messy, inaccurate, or incomplete financial records are a major red flag. They make it nearly impossible to defend your tax return if questions arise.

Action: Implement consistent, monthly bookkeeping practices. Reconcile all bank accounts, credit cards, and loan statements every month. Categorize every transaction correctly. Critically, keep organized digital and physical copies of all source documents – receipts, invoices, bank statements, and any other supporting paperwork.

Benefit: Your numbers are easily substantiated. Responding to any IRS inquiry becomes faster, less stressful, and cheaper.

2. Report consistently

Problem: Large, unexplained swings in your income or deductions from one year to the next can catch an auditor’s eye.

Action: Apply your accounting methods consistently year after year. If there are legitimate reasons for significant changes in your financials (like rapid growth or a one-time large expense), ensure these are well-documented and readily explainable.

Benefit: A logical financial story reduces suspicion. Your numbers make sense, making it easier for an auditor to understand your business.

3. Document deductions rigorously

Problem: Claiming business deductions without proper, contemporaneous proof is a fast track to having them disallowed, often with added penalties and interest.

Action: Know the specific IRS rules for common business deductions (meals, travel, auto, home office, etc.). Maintain detailed, contemporaneous records – for expenses like meals and travel, that means documenting who, what, when, where, and the specific business purpose at the time of the expense. Keep business and personal expenses clearly separated.

Benefit: You can claim deductions with confidence. If challenged, you have strong proof of their legitimacy.

4. Plan proactively 

Problem: Taking questionable or overly aggressive tax positions significantly increases your audit risk and the potential for steep penalties if those positions are overturned.

Action: Work with a qualified tax advisor to develop a sound, defensible tax strategy. Understand the reasoning behind the tax positions taken on your return. Focus on legitimate, well-documented tax planning, not risky or unsupported loopholes.

Benefit: Your tax returns are built on a stronger foundation. It demonstrates due diligence and a commitment to responsible tax management.

5. File on time

Problem: Filing late or paying taxes late automatically triggers penalties and can invite further IRS scrutiny into your affairs. Errors on returns also raise flags.

Action: Meet all tax filing deadlines – this includes income tax returns, payroll tax filings, 1099s, and any other required information returns. Pay all taxes due on time, including making accurate estimated tax payments throughout the year if required. Double-check all returns for accuracy before they are filed.

Benefit: You avoid easy-to-prevent penalties and maintain a good compliance history with tax authorities.

If an audit letter arrives…

Even with the best preparation, an audit can still happen. If you receive that letter:

• Don’t panic.
• Contact your tax advisor immediately. Do not attempt to handle an IRS audit on your own. Your advisor understands the process and can represent you.
• Gather requested documents. This is where your meticulous record-keeping will be invaluable.
• Be organized, honest, and responsive to all IRS requests by the stated deadlines, through your advisor.

The proactive steps outlined above will make this process far less daunting and significantly improve your chances of a favorable outcome.

Reduce risk, gain peace of mind

Again, while you can’t build an impenetrable fortress against IRS audits, you can significantly lower your chances of being selected and ensure you’re in the strongest possible position if it happens.

Strong financial habits, clean record-keeping, and proactive, well-documented tax planning aren’t just about compliance; they are fundamental to your business’s health and your peace of mind as an owner.

Worried about your audit risk, or want to put these best practices in place for your business? Arvo Advisors helps SMBs build resilient financial foundations and navigate tax complexities with confidence. Let’s talk.