By John W. Cashman, Jr., CPA
Tax Manager at Gray, Gray & Gray, LLP

The U.S. economic recovery has been spurred in many ways by the spirit of entrepreneurship that has led to an expansion of small businesses. The appeal of working for oneself and creating your own success is strong.

But running a small business also carries an increasing amount of scrutiny from the Internal Revenue Service (IRS). The financial controls present in a large corporation are not always so rigid in a closely held business. The IRS can come down hard on small companies that take advantage of “gray” areas in the tax code, or that get overly aggressive in claiming deductions.

How does the IRS go about selecting a business for an audit? Here are some of the most common “red flags” that could catch the attention of the IRS:

• Information provided on a tax return does not match up with information received by the IRS from other sources, such as 1099 forms, tax returns and other filings made by vendors or customers
• Misclassifying employees as independent contractors to avoid overtime or payroll taxes
• If you are an employer, missing or incorrect payroll tax filings are likely to catch the attention of the IRS
• Expensing items that should be depreciated
• Depreciating items that should be expensed
• Deducting entertainment costs as marketing expenses
• Incorrectly claiming a home office deduction

Being selected for an audit does not necessarily mean that you have done something wrong. It may be that the IRS wants to review your return to ensure its accuracy. Still, it is best to bring your accountant into the picture as soon as possible, or to engage an accounting firm that specializes in representing clients who are audited. Don’t go through the process alone.

If you are facing an IRS audit of your company’s tax return, or if you have any questions about the tax filing practices that the IRS could examine more closely, call the Gray, Gray & Gray Tax Department at (781) 407-0300.