We've talked before about personal audits, but what about corporations? The higher the potential for a "good" outcome on their end, the more likely the IRS is to conduct an audit. With the complicated requirements of the U.S. tax code for corporations, they're ripe for the picking.
The chances of audit
After some digging, I found stats on C Corp audits from past years. Some interesting numbers:
|Total Assets||Audit rate 2010||Audit rate 2014|
|Less than one million||1.4%||1%|
|$1 to $5 million||1.7%||1.2%|
|$5 to $10 million||3%||1.9%|
|$10 to $50 million||16.6%||6.2%|
In 2012, a staggering 27.1% of C Corps with over $100 million in assets were audited. S Corps, LLC's and entities taxed as partnerships, on the other hand, only had an audit rate of 0.4% for 2010 and 2014. You can see how the IRS likes to go after the "big dogs".
Tips to help avoid the ever watching eye of the IRS
If you are one of the big corporations, it's important to know that certain activities are going to invite scrutiny for an audit.
Some things to avoid:
- Expenses that are too high; be it meals, entertainment, or auto expenses.
- Claiming 100% business use of a vehicle if there is not another vehicle for personal use.
- Making loans to officers instead of payroll. This is sometimes done to get money to an officer without having to put it on the payroll so the corporation wouldn't have to pay payroll taxes (and the officer wouldn't have to pay income taxes on it). Big red flag.
- Paying unreasonably high salaries to shareholders who are also employees in an attempt to beat down profits.
- Not paying/receiving interest on officer loans; this can make it look like you're just moving money around to hide it.
- Not properly rolling retained earnings from the prior period to the current year.
- Filing forms 1096/1099 late…the IRS doesn't like late.
- Having a corporate balance sheet that doesn’t balance.
- Having profit margins that are are inconsistent with prior years.
- Reporting negative profits for several years in a row…the IRS will ask "How are you still in business?"
- If you are a corporation with retail business involving inventory…ending every year with zero ending inventory.
- Expensing too much officer life insurance. Corporations can buy policies on its' officers, but whole life policy is also considered an investment vehicle. An investment that is also an expense doesn't fly with the IRS.
With grossly high corporate tax rates, the incentive to get income off the books is massive. But — anything that is obviously done to drastically and aggressively get income off the books is a red flag to the IRS. The first question you can ask yourself is "Is the premium of being a C Corp worth it?" There are options, such as S Corps and LLC's that may have better tax advantages depending on the size of your company. There are pro's and con's to being a C Corp, and you'll want to weigh all of your options.
If a C Corp is the best choice for you, know that there are legitimate strategies to help lower your taxes…we'd recommend sticking with those. If you need assistance with tax planning or audits contact us to schedule a free consultation.