IRS

It’s a fact of life that the IRS may audit your business tax return. Of course, not all audits mean that an error occurred. It may indicate that your company’s tax return contains information that does not align with similar businesses or industry standards. The IRS uses advanced algorithms to detect any anomalies in your tax return. If the IRS spots any inconsistences on your return, it is likely your company will be audited.

Here are some common IRS red flags that can trigger an audit and how to correct them:

• Missing payroll deadlines for reporting and depositing federal payroll taxes for federal income tax withheld, Medicare or Social Security have the steepest penalties. The IRS imposes additional interest charges on the amount owed until the late deposits are paid. Setting a deposit schedule and monitoring IRS receipt for payment should negate this problem.
• Late or incorrect returns can carry a substantial penalty. Failure to file correct informational forms such as employee W-2s or taxpayer ID numbers are likely to be audit worthy. To avoid this, use taxpayer ID number verification tools, reconcile totals to payroll registers and schedule a pre-deadline review to catch and correct any errors.
• Misclassifying employees can trigger penalties, back taxes and audits. Identifying employees as independent contractors means bypassing payroll withholding and reporting. Consequences can include paying back taxes with interest for any discrepancies as well as future scrutiny. Use the Department of Labor contractor guidelines for clarity when classifying.
• Using outdated income tax withholding tables will cause the IRS to sit up and take notice, leading to charging you penalties. Make sure to have new hires fill out federal and state W-4 forms to verify employment eligibility so you can accurately run payroll. Refer to the latest payroll tax tables and correct any employment taxes as soon as possible. Delaying corrections can trigger penalties, interest and audits.
• Reporting incorrect wage and benefits calculations can result in paying significant civil or even criminal penalties. This could include incorrect overtime, misclassifying taxable fringe benefits or not paying bonuses or commissions. One way to avoid this situation and the hassle of an audit is to automate the process with payroll software.
• Poor recordkeeping is another area that can trigger further investigation. This means keeping your payroll records organized and accurate if you are called in for an audit. The IRS requires employers to keep employee tax records for at least four years after the date the tax becomes due or is paid. The DOL directs employers to retain payroll records for at least three years and timecards for at least two years. Keeping all required records organized and accessible will help your company avoid disputes if you are audited.

Although the above can all help, your best protection against time-consuming and costly IRS actions is to work closely with payroll and tax professionals. They can guide you through the IRS’ good side.

© YC Partners 2026