How to Avoid an Audit: The Solopreneur’s Compliance Checklist

If there are any three words that every solopreneur dreads, it’s these: You’re being audited.

Tax audits are a pain, and it’s normal to worry about this. But here’s some good news: While estimates vary, your chances of being audited by the IRS are relatively low. And your risk is even lower if you’re careful about your financial management and tax compliance.

Wondering what you can do to keep your business in top-top shape and (hopefully) keep the IRS away? Let’s take a look at some tax strategies you can implement for your solo business at two key times: throughout the year and at tax time. 

All Year Long: How to Set Your Solo Business Up for Success

Reducing the likelihood of an audit doesn’t just happen at tax time—it’s happening all through the year as you maintain your records.

Careful bookkeeping allows you to submit more accurate information about your finances, which limits any discrepancies that might trigger an audit. If an audit does happen, you’ll have all of the records you need to substantiate your income and expenses.

Here are a few recordkeeping tips you can use to make tax compliance an ongoing priority in your solo business:

• Use separate bank accounts: Having a dedicated business bank account and a debit card for your business transactions simplifies your recordkeeping and creates a clear paper trail, just in case you need one. You don’t need to take a trip to the bank—Lettuce can set up your business bank account for you. 
• Track every transaction: Keep meticulous records of all of your business-related transactions, like purchases and invoice payments. Doing so helps you maximize your tax deductions and ensure that the information you submit at tax time is as accurate as possible. Think this sounds like a lot of elbow grease? Lettuce will track and categorize every transaction for you. 
• Organize your tax documents: From receipts and invoices to financial reports and tax forms, there’s a lot of paperwork to keep track of for your business-of-one. Ditch the dusty filing cabinet and opt for an automated accounting solution like Lettuce. You’ll have access to all of the information and insights you need in one easy-to-use place.

At Tax Time: How to Confidently File Your Taxes

If you put the above tips into play throughout the year, that already makes tax time a lot easier. But, when it comes to prepping and filing your taxes, there are a few other tax strategies to submit a more bulletproof return (and keep the IRS happy).

• File on time: Submitting your tax return after the deadline not only leads to penalties, but it could inspire the IRS to take a closer look. Turn everything in on time (or request an extension if you need one) to ensure you’re following all the rules and staying off the IRS’ radar. 
• Pay your estimated quarterly taxes: Tax time is usually at the forefront of most solopreneurs’ minds, but other important tax deadlines crop up throughout the year. Your quarterly estimated payments are a big one. Making these payments on time in April, June, September, and January helps you avoid underpayment penalties and shows the IRS that you’re always serious about tax compliance. 
• Be honest about your deductions: Writing off your legitimate business expenses is a great way to lower your tax bill as a business-of-one, but legitimate is the operative word. Too many off-the-wall expenses will set off alarm bells. If you’re wondering whether or not an expense is deductible, ask yourself this: Does this help my business generate revenue? If the answer is “yes,” you can safely write it off—without raising any eyebrows at the IRS. 
• Understand S Corp tax rules: Electing an S Corp tax status can be a major money-saver for solo businesses, but it does come with more specific requirements and filing rules. If you’re filing as an S Corp, make sure you’re in the loop about the ins and outs of S Corp taxes. Already feel your eyes glazing over? Lettuce will handle all of this for you, so you can skip the confusion and stay compliant. 

There’s more good news: Particularly if you’re a high earner, electing an S Corp tax status can further reduce your chances of being audited. While estimates vary, S Corps are audited significantly less frequently than sole proprietorships.

S Corps have the lowest audit rate compared to other business entities, with as few as 0.1% of S Corps being audited. Other data shows a 0.5% audit rate for S Corps. In comparison, a sole proprietor earning upwards of $100,000 per year has a 2-4% audit rate. It’s proof that completing an S Corp election doesn’t just help you save money—it can also save you some stress.

Still worried about an audit? That’s where the Lettuce Guarantee comes in. If our work is challenged by the IRS, we’ll be first in line to defend it—no charge to you. If you do get audited, Lettuce will help you through the entire process. 

3 Other Red Flags to Avoid (That Could Trigger an Audit)

Though your chances are surprisingly low, there’s never an ironclad guarantee that you won’t get audited. However, implementing the above tax strategies—and avoiding these other common red flags—can help you keep your business compliant and steer clear of scrutiny from the IRS. 

1. Setting an unreasonable salary: If you’re an S Corp, you’ll need to set a reasonable salary for yourself. This is the only portion of your business income that you pay self-employment tax on, which makes it tempting to pick a low number. However, the IRS pays close attention to this. So, be honest and set a salary that’s similar to what you’d earn for that work as a full-time employee. If you’re worried, Lettuce can automatically calculate your reasonable salary for you.
2. Making a lot of large cash transactions: When you need to make a large purchase for your business-of-one, use either a check or your business credit or debit card—not cash. It’s helpful to have that paper trail to support your business transactions.
3. Failing to report all of your income: Lower taxable income means lower taxes, but that doesn’t mean you want to hide income. Your safest bet is to report all of the income you receive through your solo business—even if you don’t get a 1099 from a client.

Don’t Sweat the IRS

Nobody wants to be audited—and, unfortunately, there’s no way to guarantee it won’t happen to your business-of-one. However, there are smart, proactive steps you can take to lower your chances.

By staying organized year-round and being honest and timely when tax season hits, you can keep your solo business squeaky clean in the eyes of the IRS.

Want even more peace of mind? Let Lettuce do the heavy lifting. From categorizing your transactions to paying your quarterly taxes, Lettuce can help you stay compliant and confident.