Why this matters

An IRS audit is less about punishment and more about verifying correct tax reporting. In my 15 years advising small businesses I’ve seen most audits start from basic, fixable issues: incomplete records, payroll mistakes, or unusually large deductions for the company’s size.

Top audit triggers and how to avoid them

  • High or unusual deductions for the business type

  • Why it flags: Deductions that look out of line with industry norms or your revenue can be selected for review. The IRS pays attention when expenses are large relative to income.

  • How to reduce risk: Keep receipts, invoices and contemporaneous mileage logs. Apply reasonable allocation methods for shared items (home office, vehicle). For more on expense scrutiny, see What Triggers an Expanded Audit of Business Expense Deductions (finhelp.io).

  • Income mismatches (1099s, bank deposits, point‑of‑sale)

  • Why it flags: The IRS gets copies of 1099s and W‑2s and cross‑checks them against your return. Unreported third‑party payments or odd timing raise questions.

  • How to reduce risk: Reconcile your bank statements, merchant‑processor reports, and 1099s before filing. Track cash and gig income in a consistent ledger.

  • Payroll and employment tax errors

  • Why it flags: Incorrect payroll filings, unpaid employment taxes, or missing W‑2/1099 reporting prompt deeper review and state referrals.

  • How to reduce risk: Use payroll software or a reputable payroll service, deposit payroll taxes on time, and keep payroll registers and Form W‑2/1099 copies.

  • Large round numbers or uniform receipts

  • Why it flags: Repeated round numbers (e.g., exactly $5,000 every month) can imply estimated or fabricated figures.

  • How to reduce risk: Record actual amounts and avoid rounding consistently; keep invoices and POS reports to back reported figures.

  • Poor or missing documentation

  • Why it flags: Lack of receipts, mileage logs, or contracts makes otherwise legitimate deductions hard to substantiate.

  • How to reduce risk: Implement a record retention policy and store digital copies. See our guide on How to Implement a Record Retention Policy to Reduce Audit Risk (finhelp.io) and the IRS guidance on how long to keep records (IRS Tax Topic 403).

Practical, low‑cost controls every small business should adopt

  1. Separate accounts: Use dedicated business bank and credit card accounts to make matching transactions easier.
  2. Monthly reconciliations: Reconcile bank and merchant statements monthly to catch mistakes early.
  3. Standardize receipts: Collect vendor invoices, save digital copies, and require written memos for cash expenses.
  4. Mileage & time logs: Use an app or spreadsheet to record business miles and the business purpose contemporaneously.
  5. Payroll discipline: Automate tax deposits and filings or outsource payroll to reduce human error.
  6. Reasonable basis for deductions: Document the business purpose and calculation for large or unusual deductions.

Record retention and timelines

  • General rule: Keep tax records at least three years after filing (IRS Tax Topic 403), but longer retention is wise for property, employment tax and unfiled returns. See IRS guidance: https://www.irs.gov/taxtopics/tc403 and our practical record policy guide (finhelp.io).

Responding to an IRS contact

If the IRS sends a notice, respond promptly and precisely. Many audits begin as correspondence requests. Organize documents and consider preparing a digital audit packet. For tips on timely replies, review Preparing for a Correspondence Audit: Responding to Mail Requests Quickly (finhelp.io).

When to bring in a pro

  • Complex issues (multi‑year discrepancies, payroll trust fund concerns, or proposed penalties) — engage a CPA or tax attorney.
  • For a first review before filing: a CPA can spot red flags and suggest conservative reporting choices.

Real‑world example

A retail client consistently reported identical monthly sales and large COGS deductions. We implemented monthly POS exports, tied deposits to sales, and replaced estimated numbers with actuals. When the IRS contacted them, the organized documentation closed the case quickly with no adjustments.

Final checklist to lower audit risk

  • Use separate business accounts and monthly reconciliations
  • Track and document every deduction with receipts and purpose
  • Reconcile 1099s, bank deposits, and merchant reports before filing
  • Automate or outsource payroll and file on time
  • Keep records for at least three years and longer where advised
  • Respond to IRS notices quickly and professionally

Authoritative sources & further reading

Professional disclaimer

This article is educational and does not replace personalized tax advice. For decisions that affect your taxes, consult a qualified CPA or tax attorney who can review your records and circumstances.