Top 5 Reasons Small Business Owners Get Audited (And How to Avoid Them)
Introduction
If you follow these steps and listen to this article till the end, your chances of getting audited by the IRS will dramatically go down. In other words, you’re more likely NOT to get letters and correspondence from the IRS or random selection because what you put on your tax return was in line with what the IRS was expecting from the kind of business you operate.
Every year, small business owners live in fear of the IRS. The very IRS that was given the responsibility to collect taxes from citizens, corporations, and taxpayers in general. Now we sit here and stay in fear of them coming after us for money that we earned.
And all this happens because we lack the knowledge that we need as taxpayers. We lack the understanding of what they’re expecting from us. We lack the understanding of what our responsibilities are and what the rules are around them. We lack the understanding of how certain categories on a tax return can unintentionally trigger more examination, more taxes, more penalties—all while you’re trying to do everything right. You just didn’t know something.
So let’s fix that. Let me show you what to watch out for.
Table of Contents
- Who’s Really Responsible for Your Tax Return
- The Game Nobody Taught You
- Reason #1: Travel and Meal Deductions
- Reason #2: Home Office Deductions
- Reason #3: Vehicle Expenses
- Reason #4: Cash Businesses
- Reason #5: Mismatched 1099 Forms
- Key Takeaways
- FAQ
Who's Really Responsible for Your Tax Return
Before I get into the five reasons, let me tell you something that most people don’t understand.
Your tax professional is not going to be on the hook for filling out your tax return and filing it for a fee. They are only required to ask you questions and sometimes ask for proof of expenses, but not all the time.
If you reply to them in an email and tell them to put those numbers on your tax return, they will simply put it. And that email is the evidence for your tax preparer so he or she is off the hook. It’s all on you.
Let me say that again: when the IRS comes asking questions, your tax preparer is going to show them the email where you told them what to put on your return. And then the IRS is coming after you, not your preparer.
So you can’t just blame your accountant. You can’t say, “Well, they should have known better.” It’s your responsibility to know what you’re claiming and whether it’s legitimate.
The Game Nobody Taught You
Would you play a game without knowing the rules? Would you go out on a basketball court and just start throwing the ball around without knowing what a foul is, what traveling is, what the boundaries are?
Of course not. You’d look like a fool.
When you’re teaching a kid to play sports—any sport—what’s the first thing you do? You teach them the rules. You show them the boundaries. You explain what they can do and what they can’t do. Without that, they have no chance of being successful at that game.
So why do taxpayers put numbers on their tax return without knowing the rules?
That’s what most people do. They hear about deductions and they think, “Oh, I’ll just write that off.” They don’t know the boundaries. They don’t know the parameters. They don’t know what the IRS considers fair play.
And then they’re shocked when the IRS shows up with questions.
Reason #1: Travel and Meal Deductions
The number one reason small business owners get audited? Travel and meal deductions.
Here’s what happens: You work hard. You take clients out to dinner. You travel for business. You think, “I can write all this off.”
But you don’t know the rules. So you start writing off every meal you eat during the workday. You write off that family vacation because you “thought about work” for five minutes on the beach.
You send an email to your tax preparer: “Put $30,000 in travel and meals.” They do it. They’re off the hook. You’re not.
The IRS sees this. And their computer system—called the DIF score—flags your return.
Why? Because your travel and meal expenses don’t match what other people in your industry are claiming. If you’re making $100,000 but claiming $30,000 in travel and meals, that doesn’t make sense. It’s out of bounds.
What the IRS Is Really Looking For
Here’s what most people don’t understand: the IRS isn’t just looking at travel and meals. They’re using those high expenses as a clue that you might have other problems on your return. Unreported income. Personal expenses being written off as business. Made-up deductions.
So when they see high travel and meals, they dig deeper. And that’s how you end up with an audit letter and questions you can’t answer.
The Rule You Need to Know
Meals are only deductible if they’re directly related to business. That means you’re meeting with a client, a vendor, or a business partner. Or you’re traveling overnight for work.
Your daily lunch because you were “working”? Not deductible. That’s personal. You have to eat whether you’re working or not.
Travel has to be overnight and away from your tax home—the place where you normally do business. Driving across town for a meeting? That’s not travel. That’s commuting.
How to Avoid It
- Only write off meals that are actually for business—client meetings, business travel
- Keep receipts AND notes about who you met with and why
- Write it on the back of the receipt, or send yourself an email right after
- Document it when it happens, not six months later when the IRS asks
- Keep your expenses realistic—if everyone in your industry spends 10% of their income on travel, don’t spend 30%
- Remember: your tax preparer just puts down what you tell them
Reason #2: Home Office Deductions
The second reason? Home office deductions.
Everyone thinks, “I work from home, so I can write off part of my house.” But they don’t know the rules. They don’t know the boundaries.
The IRS says your home office has to be used ONLY for business. Not mostly. Not usually. ONLY.
This is a hard boundary. If you cross it, you’re out. The deduction doesn’t count.
A Personal Example
Let me give you a personal example. I’ve been operating some part of my business from home. I have my entire upstairs set up as a studio where I record these videos. My wife works from here too. This entire place is an office used exclusively for business.
But then we have kids. They come and play here once in a while when we’re both working. When we’re both busy working, the kids will come, put their toys out, and do their homework.
Now, if you go by the rules, it’s not being exclusively used for business. And the thing about rules is this: eventually, you’re going to have to tell on yourself and reverse all the deductions you’ve taken. And at that time, you’re going to regret those choices and deductions. Because penalties and interest alone will destroy you. I have seen it happen, and trust me, you don’t want to go that route.
The Two-Office Problem
Another reason I don’t take this home office deduction is because I also have an office, and we use the expenses of that office to claim the office deductions. Now I can’t tell the IRS that I’m so hardworking that I have an office deduction AND a home office deduction. It’s not going to add up. The IRS is going to ask, “Which one is your principal place of business?” And if I can’t answer that clearly, I could lose both.
The Rule You Need to Know
Your home office must be used exclusively and regularly for business. Exclusively means ONLY for business. Regularly means you use it all the time, not once a month.
And it has to be your principal place of business—the main place where you do the administrative work for your business. Or it has to be a place where you meet clients regularly.
If you have another office somewhere else, you can’t claim both unless you can clearly prove which one is your principal place of business.
How to Avoid It
- Make sure the space is ONLY for business
- Take pictures proving it
- Measure the room so you know the square footage
- Keep it clean—no personal stuff, no guest bed, no kids’ toys, no homework at the desk
- If you’re not sure you qualify, don’t guess
- Don’t send your tax preparer an email saying “claim home office deduction” if you know it doesn’t qualify
I don’t claim this deduction anymore because my situation doesn’t qualify. But you might, depending on your setup. Just make sure you know the rules before you claim it. Because when the IRS comes back years later and disallows it, you’ll owe back taxes plus penalties plus interest. And that will destroy you financially.
Reason #3: Vehicle Expenses
Number three: vehicle expenses.
Here’s the mistake: people think driving to work is a business expense. It’s not. That’s called commuting, and it’s never deductible. Never.
Business mileage is when you drive FROM your office to meet a client, go to a job site, or pick up supplies. Not when you drive TO your office from home in the morning.
But people don’t know this. So they write off all their mileage. They email their tax preparer: “I drove 40,000 miles this year.” The preparer puts it on the return. The IRS sees it doesn’t match their income or their business type, and boom—audit letter.
When the Numbers Don’t Make Sense
I’ve also seen people claim they drove 40,000 miles for a business that only made $50,000. The IRS looks at that and says, “That doesn’t make sense. How are you spending that much on driving but making so little money?” And that’s how you invite questions you’re not prepared to answer.
The Rule You Need to Know
Commuting is personal. Driving from your home to your regular place of business is not deductible.
Business mileage starts when you leave your office to go somewhere else for work. Or if you work from home and you drive to meet a client or go to a job site.
And you need a mileage log. Not just “I drove a lot.” You need dates, starting point, ending point, miles driven, and business purpose. Without that, the IRS can disallow everything.
How to Avoid It
- Keep a real mileage log—use an app, notebook, or spreadsheet
- Document: dates, starting point, ending point, miles driven, business purpose
- Be realistic—if your mileage seems too high for your industry and income, the IRS will notice
- Remember: your tax preparer is just putting down what you tell them
Reason #4: Cash Businesses
Number three: vehicle expenses.
Here’s the mistake: people think driving to work is a business expense. It’s not. That’s called commuting, and it’s never deductible. Never.
Business mileage is when you drive FROM your office to meet a client, go to a job site, or pick up supplies. Not when you drive TO your office from home in the morning.
But people don’t know this. So they write off all their mileage. They email their tax preparer: “I drove 40,000 miles this year.” The preparer puts it on the return. The IRS sees it doesn’t match their income or their business type, and boom—audit letter.
When the Numbers Don’t Make Sense
I’ve also seen people claim they drove 40,000 miles for a business that only made $50,000. The IRS looks at that and says, “That doesn’t make sense. How are you spending that much on driving but making so little money?” And that’s how you invite questions you’re not prepared to answer.
The Rule You Need to Know
Commuting is personal. Driving from your home to your regular place of business is not deductible.
Business mileage starts when you leave your office to go somewhere else for work. Or if you work from home and you drive to meet a client or go to a job site.
And you need a mileage log. Not just “I drove a lot.” You need dates, starting point, ending point, miles driven, and business purpose. Without that, the IRS can disallow everything.
How to Avoid It
- Keep a real mileage log—use an app, notebook, or spreadsheet
- Document: dates, starting point, ending point, miles driven, business purpose
- Be realistic—if your mileage seems too high for your industry and income, the IRS will notice
- Remember: your tax preparer is just putting down what you tell them
Reason #5: Mismatched 1099 Forms
Number five: mismatched 1099 forms.
Here’s what happens: You get paid by a client. They send you a 1099 form showing they paid you $50,000. They also send a copy to the IRS.
But on your tax return, you only report $40,000. Maybe you forgot about some payments. Maybe you thought you could leave some income off.
The Automatic Match System
The IRS’s computer automatically compares the 1099s they received to your tax return. If the numbers don’t match, you get an automated letter—called a CP2000.
This isn’t even a human reviewing your return. It’s a computer catching the mismatch.
I’ve seen people get CP2000 notices saying they owe $15,000 because the IRS thinks they didn’t report income. Sometimes the person really did forget. Sometimes the 1099 is wrong. Either way, now you have to deal with it.
This is another form of underreporting income—and it’s one the IRS catches automatically.
The Rule You Need to Know
The IRS gets copies of your 1099s before you even file your taxes. They already know how much income you should be reporting.
If your tax return doesn’t match their records, you’re getting a letter. Automatically.
How to Avoid It
- Reconcile all your 1099 forms before you file
- Make sure the income on your tax return matches what the IRS received
- If you get a 1099 that’s wrong, contact the person who sent it and ask them to correct it
- Don’t ignore it and hope the IRS doesn’t notice—they will, it’s automated
- Give all your 1099s to your tax preparer
- Make sure they match what goes on your return
Key Takeaways
- You are responsible for your tax return—not your tax preparer. They put down what you tell them.
- The IRS uses a DIF score system to compare your return to others in your industry. If your numbers are out of bounds, you get flagged.
- Travel and meal deductions must be directly related to business and properly documented. Your daily lunch doesn’t count.
- Home office deductions require exclusive use for business only. Kids doing homework in that room disqualifies it.
- Commuting is never deductible. Business mileage starts when you leave your office to go somewhere else for work.
- Cash businesses are watched closely. Your bank deposits must match your reported income.
- 1099 mismatches trigger automatic IRS letters. The computer catches these before a human even looks at your return.
- Know the rules before you play the game. Don’t guess on deductions—that’s how you invite audits.
FAQ
What is the IRS DIF score and how does it affect my audit risk?
The DIF score (Discriminant Function Score) is a computer system that scores your tax return based on how likely it is that something’s wrong. The IRS compares your numbers to everyone else in your industry. If your deductions are way higher than average or your income seems low compared to your expenses, your DIF score goes up and your return gets flagged for potential examination.
Can my tax preparer be held responsible if my return is audited?
No. Your tax professional is not on the hook for filling out your tax return and filing it for a fee. They are only required to ask you questions and sometimes ask for proof of expenses. If you reply to them in an email and tell them to put those numbers on your tax return, they will simply put it. That email is the evidence for your tax preparer so they’re off the hook. It’s all on you.
What meals and travel expenses can I actually deduct?
Meals are only deductible if they’re directly related to business—meeting with a client, vendor, or business partner, or traveling overnight for work. Your daily lunch while working is not deductible because you have to eat whether you’re working or not. Travel has to be overnight and away from your tax home. Driving across town for a meeting is commuting, not travel.
What does "exclusive use" mean for home office deductions?
Exclusive use means ONLY for business. Not mostly. Not usually. ONLY. If your kids do homework in that room, if guests sleep there even twice a year, if you fold laundry there, it doesn’t qualify. You also can’t claim both a home office and a separate office unless you can clearly prove which one is your principal place of business.
How does the IRS catch unreported income from cash businesses?
The IRS uses a “Cash T” analysis where they look at your bank deposits and compare them to your reported income. If they don’t match, you get a letter. For example, if you deposited $200,000 in your bank but only reported $150,000 in income, they’ll ask where the other $50,000 came from. If you can’t explain it, they assume it’s unreported income.
What happens if my 1099 forms don't match my tax return?
The IRS’s computer automatically compares the 1099s they received to your tax return. If the numbers don’t match, you get an automated letter called a CP2000. This isn’t even a human reviewing your return—it’s a computer catching the mismatch. You’ll need to either prove the 1099 is wrong or pay taxes on the unreported income plus penalties and interest.
What documentation do I need to keep for vehicle expenses?
You need a mileage log with dates, starting point, ending point, miles driven, and business purpose. Not just “I drove a lot.” The IRS can disallow everything if you don’t have proper documentation. And be realistic—if you’re claiming 40,000 miles but only making $50,000, the IRS will question whether that makes sense for your business.
Final Thoughts
The IRS isn’t randomly picking people to audit. They have rules. They have systems. They have a computer that scores your tax return and compares it to everyone else in your industry.
If you know the rules and you stay within the boundaries, your chances of getting audited go way down.
But if you’re just guessing—if you’re writing off things without knowing if they’re actually deductible—you’re inviting questions you can’t answer.
You wouldn’t play a sport without knowing the rules. So don’t do your taxes without knowing them either.
And don’t think your tax preparer is going to save you. They’re just putting down what you tell them. If you give them bad information, that’s your problem when the IRS comes asking.
The next article covers underreporting income in detail—the number one thing that gets business owners in trouble with the IRS. It’s not always intentional. A lot of times, people just don’t know what counts as income or they forget to report something. But the IRS doesn’t care if it was an accident.
If you’re not sure about any of this, don’t guess. The team at D2 Tax can look at your specific situation and help you understand what applies to yo