Guide to Avoiding an IRS Audit

Hire a good accountant and heed the advice you get

Finding the right accountant is one of your most important tasks. It's best to hire someone who's familiar with small business, and it's even better to retain an accountant with experience in your specific industry. For example, if you own a restaurant, you'd be wise to find an accountant who's dealt with restaurants and understands the need to collect taxes on employee tips — an issue that trips up many restaurant owners.

I recommend: You can shop for a Certified Public Accountant or verify the standing of one you're considering through the national CPA Directory. You can also try the Directory of Accounting Professionals, which includes CPA's, other accountants and enrolled agents. Also check out these tips on hiring a CPA.

Watch your deductions.

One of the perks of business ownership is the ability to write off expenses and reduce taxes. But be careful. Oversized deductions are a red flag to the IRS and can trigger an audit. Get caught slipping personal expenses into the business mix and you might find yourself not only facing a back-due tax bill but penalties to boot.

I recommend: Brief yourself on the range of small business tax deductions. Also check out the IRS overview of business deductions.

Make sure your contractors aren't employees

The IRS has strict rules governing the use of independent contractors. Misclassified contractors are a favorite target of IRS auditors.And it's easy to slip up because the rules are complex.

I recommend: Use the IRS fact sheet, Employee or Independent Contractor? You should also be aware of special rules governing so-called statutory employees who are sometimes misclassified by businesses as contractors. Read up on statutory employees in the IRS Employer's Supplemental Tax Guide.

Collect, pay and record payroll taxes

If you have employees, it's your responsibility to make all required payroll deductions. The IRS takes this responsibility very seriously and can be harsh on business owners who slip up. The task is especially important for restaurant owners who are required to make deductions for tips.

I recommend: Review and follow the IRS guidelines for employee taxes. Business software like QuickBooks can help automate the payroll deduction process for you. You'll also need to keep records for four years. To find out what records you need to retain, review this checklist of employee records.

Keep good records on all cash transactions

If you're in a business that handles a lot of cash, you can expect the IRS to be suspicious. Cash doesn't leave as distinct a paper trail as other transactions. If you're living the high life but reporting low income from a cash business, don't be surprised if an IRS auditor knocks.

I recommend: Keep thorough records of cash transactions. Use a software system and keep records daily and monthly of all cash transactions. Be sure to report each cash payment over $10,000 as required by law.

Regularly view your anti-audit defenses

At least once a year, check your IRS compliance situation, preferably with your accountant. Tax time is usually most convenient and allows you to make any necessary adjustments before filing.

I recommend: For a quick review, check out What Auditors Look For When Examining a Business and the related Why the Self Employed are Audit Targets.