New IRS Audit Focus for Small Businesses: Red Flags to Watch

The Internal Revenue Service (IRS) has announced a renewed focus on auditing small businesses in 2025, aiming to ensure compliance and address underreported income. This initiative is part of the IRS’s broader efforts to close the tax gap and promote fairness in the tax system.

Key Areas of IRS Focus:

Employee Classification: Misclassifying workers as independent contractors instead of employees can lead to significant tax liabilities. The IRS emphasizes the importance of correctly identifying workers to ensure proper tax withholding and reporting. Businesses are advised to review their worker classifications to avoid potential audits and penalties. DeLeon & Stang+4IRS+4DSDA Law+4 DSDA Law+1boeshaarlaw.com+1

Underreported Income: Failing to report all income, including cash transactions, can trigger IRS scrutiny. The IRS utilizes advanced data analytics to detect discrepancies between reported income and actual earnings. Maintaining accurate records and reporting all income is crucial for compliance. boeshaarlaw.com+5The Hartford+5Taxes for expats | US expat tax service+5 GreenGrowth CPAs

Excessive Deductions: Claiming disproportionately large or unsubstantiated deductions relative to income may raise red flags. The IRS advises that all business expenses must be both ordinary and necessary, and proper documentation should be maintained to substantiate these claims. The Hartford+4Indinero+4business.com+4 The Hartford+1DeLeon & Stang+1

Understanding the Audit Process:

The IRS typically has a three-year window from the date a tax return is filed to initiate an audit. However, this period can extend to six years if more than 25% of income is underreported. In cases involving fraud or failure to file a return, there is no statute of limitations, allowing the IRS to audit indefinitely. ledgerfi.co+2Taxes for expats | US expat tax service+2Barbara Weltman+2 ledgerfi.co

Penalties for Non-Compliance:

Businesses found to be non-compliant may face accuracy-related penalties, which are typically 20% of the underpayment attributable to negligence or disregard of rules. Additionally, interest accrues on unpaid taxes and penalties from the due date of the return until payment is made in full. IRS

Proactive Measures for Businesses:

To mitigate the risk of an IRS audit and ensure compliance:

Conduct Regular Tax Compliance Reviews: Regular internal audits can help identify and rectify potential issues before they attract IRS attention.

Maintain Accurate and Organized Records: Detailed documentation of all income, expenses, and deductions is essential. Utilizing accounting software can aid in keeping meticulous records.ledgerfi.co+2Indinero+2Barbara Weltman+2

Ensure Correct Worker Classification: Review and, if necessary, revise worker classifications to align with IRS guidelines, ensuring proper tax treatment.DSDA Law

Consult with Tax Professionals: Engaging with experienced tax advisors can provide guidance tailored to your business’s specific circumstances, helping navigate complex tax laws and regulations.

Stay Compliant with PAMC:

At Powerhouse Anchor Management Consulting (PAMC), we specialize in assisting businesses to navigate the complexities of tax compliance. Our Tax Risk Review services are designed to uncover vulnerabilities in your filings, documentation, and reporting processes. By partnering with us, you can proactively address potential issues, ensuring your business remains compliant and audit-ready.

Take Action Today:

With the IRS intensifying its focus on small business audits in 2025, now is the time to act. Contact PAMC to schedule a comprehensive Tax Risk Review and safeguard your business against potential audits and penalties.