Avoid an Audit for Your Small Business: Write-Offs That Raise Red Flags

Who wants to be audited by the Internal Revenue Service? No one. It’s a tedious and stressful process that we’d all rather avoid.

So what’s the secret? Well, there’s no foolproof way to avoid a tax audit, but you can reduce your risks by being selective about which business expenses you write off on your taxes. It’s all about knowing what tax auditors are looking for — the kind of “business expenses” that look just a bit suspicious. 

What are those red-flag write-offs? Let’s talk about them. Oh, and maybe bookmark this page so you can refer back to it when you’re getting ready to file your taxes. ?

Tax red flag #1: Excessive meals and entertainment

Spending lots of money on meals looks a bit suspicious — especially for online businesses. Unless you’re traveling all the time, it doesn’t make sense to spend a lot of money on meals (at least in terms of those meals being a legit write-off).

Now, that’s not to say that you can never write off your meals. There are several situations when you can deduct 50% of your food/meal costs as a business expense (according to 2023 IRS regulations):

• Business meetings with a client
• In-office meetings
• Snacks and coffee for employees
• Meals when traveling for work
• Food at conferences

But wait — if you host an employee event, like a holiday party, you get to deduct 100% of those food expenses! 

You can also deduct the full cost of any meals that are essential to your business. For example, if you’re a food blogger, you can write off the entire cost of the ingredients you use to make the recipes you post on your site.

Legitimate expenses should correlate with your business making more money. 

You have lunch with a client and they decide to book with you? Legit write-off. You go to a coffee shop every morning to work for a few hours and enjoy a fancy latte and scone? Not a deductible business expense. (Much as I wish it were!)

If you’re running an online business, an auditor might look twice at your returns if you have excessive food and travel costs. So what does “excessive” mean? There’s not really a dollar-value threshold — it’s more about your industry, revenue, business growth, and history of profit. 

Basically, auditors know what’s fairly “normal” in terms of expenses for businesses like yours — and they may pull your past tax returns to compare. If your write-offs are far higher than that what’s expected, it might raise that red flag.

Bottom line: Only write off expenses that are truly related to your business, and make sure you’ve got evidence in case you need to prove that those expenses were legitimate. (Yes, that means itemized receipts.)

Side note: Although many financial resources talk about “food and entertainment “ write-offs, the truth is that most entertainment costs aren’t deductible at all. 

Tax red flag #2: Client gifts

Can you give your clients gifts — and more importantly, can you write off the cost of those gifts? You can, but only up to a certain amount.

What’s the limit? You can deduct up to $25 per person per year. So if you have 10 clients, you can’t deduct more than $250 for the year in “gift” expenses.

Now, does that mean you can’t spend more on a nicer client gift? No. You can spend as much as you want — but you can only deduct $25 on your taxes.

Side note: Giving clients branded merch is a bit of a gray area because the cost of that swag could count as a marketing expense. However, many CPAs (especially those who are risk-averse) won’t deduct these costs, so make sure you and your CPA are on the same page here.

Avoiding a tax audit is all about not raising suspicions

Unfortunately, there’s no way to guarantee that you’ll never get audited. But you can significantly reduce the risk by avoiding write-offs that raise red flags: excessive meal and travel costs and expensive client gifts. 

Follow the current IRS rules for business deductions, and when in doubt, ask yourself this. Is the expense ordinary (for your industry) and necessary (for your business)? If it’s a pretty standard purchase for businesses like yours and it correlates directly with your business making money, it’s probably a legitimate write-off.

Remember, always record your expenses in your books — and keep those receipts! And if you want some help tracking those transactions, hire a bookkeeper — maybe one who worked as an auditor and can help you avoid those red flags (yep, that’s me ?).

My team and I specialize in helping online business owners keep track of their finances — and truly understand what those numbers mean! Plus, we’ll get all your bookkeeping paperwork ready for tax time — all you have to do is send it over to your CPA! So if you want to work with people who truly care about helping your business succeed, let’s chat!