Background

IRS audits are routine examinations intended to verify that reported income, deductions, and credits are accurate. Selection can come from computerized screening (discrepancies against norms), third‑party information (mismatched 1099s or W‑2s), or random checks. See IRS guidance on audits and examinations for business taxpayers (IRS Publication 556 and IRS small business audit pages).

How audit triggers work

  • Algorithmic filters compare returns to IRS norms for industry, size, and income. Returns that deviate materially get flagged. (IRS uses information returns and statistical models.)
  • Third‑party reporting mismatches: the IRS receives copies of W‑2s and 1099s; if those totals don’t match your return, that generates a notice.
  • Human review: an agent may select returns for deeper review when numbers or documentation look inconsistent.

Common small business audit triggers

  • Large or unusual deductions relative to income (meals, travel, vehicle, or home‑office deductions claimed without support).
  • Repeated or deep losses for active businesses (especially if lifestyle suggests personal income beyond what’s reported).
  • Mismatched information returns (missing or inconsistent 1099‑MISC/1099‑NEC or W‑2 totals).
  • Cash‑intensive businesses with poor documentation (restaurants, salons, contractors).
  • Failing to file payroll or payroll tax returns while paying workers.
  • Amended returns filed frequently or large, unexplained corrections.

Why documentation matters (practical view)

In my practice working with small businesses, the most effective deterrent to an audit escalation isn’t avoiding deductions — it’s proving them. Well‑organized supporting records (receipts, invoices, bank statements, mileage logs) reduce the time and cost of responding and greatly improve the chance of a favorable result.

Actionable steps to reduce audit risk

  1. Keep timely, organized records
  • Reconcile bank and credit card accounts monthly. Retain receipts tied to each expense. The IRS recommends keeping records for at least three years; for large omissions the lookback can be six years (see IRS recordkeeping guidance).
  • Consider digital backups and searchable naming conventions to speed retrieval.
  1. Match third‑party reporting
  • Verify all 1099s and W‑2s issued to and from your business match the amounts you report. File corrected information returns promptly if needed.
  1. Separate personal and business finances
  • Use separate bank and credit card accounts and a dedicated business entity when appropriate. Avoid commingling personal and business expenses.
  1. Be conservative and consistent with deductions
  • Apply standard industry practices for depreciation, meals, vehicle logs, and home‑office calculations. When a deduction is borderline, document the business purpose clearly.
  1. Use payroll and employment tax best practices
  • Treat workers correctly (employee vs contractor), file employment tax returns on time, and issue accurate payroll forms.
  1. Automate recordkeeping where possible
  1. Get professional review
  • Have a CPA or enrolled agent review your return, especially if you claim large deductions or complex credits. A professional review can catch reporting gaps and create prepared explanations for items likely to draw attention.

If you receive an audit notice

  • Don’t ignore it. Read the notice carefully for the deadline and the requested documents.
  • Gather the requested records and respond within the timeframe. If you need more time, communicate promptly to request an extension or explain the situation.
  • Consider representation: a tax professional can correspond with the IRS on your behalf. See FinHelp’s checklist for assembling a compact audit package: “Preparing a Compact Audit Package: What to Include” (https://finhelp.io/glossary/preparing-a-compact-audit-package-what-to-include/).

Real‑world example

A landscaping client claimed large equipment purchases and business vehicle use without contemporaneous receipts and a mileage log. After an IRS correspondence audit, we provided organized invoices, canceled checks, and a reconstructed mileage log. The agent accepted most deductions; the client avoided penalties by cooperating early and supplying substantiation.

Quick audit‑risk checklist (what to review before filing)

  • Do reported gross receipts match bank deposits and 1099s?
  • Are large deductions supported with receipts and business purpose notes?
  • Have you issued and reconciled 1099s for independent contractors?
  • Are payroll taxes filed and paid where employees exist?
  • Do losses appear reasonable for the business activity?

Further reading and related FinHelp guides

Authoritative sources

Professional disclaimer

This article is educational and does not replace personalized tax advice. If your business faces an audit or you need tailored tax planning, consult a qualified CPA, enrolled agent, or tax attorney.