5 IRS Audit Red Flags Business Owners Should Know

Running a business already feels like a high-wire act — the last thing you need is the IRS deciding to take a closer look at your tax return. While not every audit is catastrophic, some common red flags can fast-track your file straight to an auditor’s desk.

Before we jump into the red flags, let me be very clear on something:

Never send the IRS your originals.
Make copies. Send them by registered or certified USPS mail — not FedEx, not UPS, not carrier pigeon. The courts have ruled (over and over again) that USPS is the only method that gives you provable timely delivery. Most recently in Lynch v. Commissioner of Internal Revenue (2024). That little green certified slip? That’s your golden ticket.

As a tax professional who’s seen plenty of these letters come across my desk, here are the top five audit triggers I warn my clients about (and how you can avoid them).

1. You're Not Paying Yourself a Reasonable Salary

If you own an S Corp or C Corp and actively work in the business, the IRS expects you to pay yourself a reasonable salary. Not just take distributions. Not just guess and hope for the best.

The IRS hasn’t given a clear formula (because that would be too easy), but based on audits and court cases, we know this:
If line 7 on your S Corp return (officer compensation) is $0, you’re practically inviting an audit.

I use what’s called the many hats method, backed by compensation analysis software, to help clients document their role and determine what someone would realistically get paid to replace them. Not doing this can result in:

• Late payroll tax penalties

• Loss of S Corp status

• Up to $5,000 in penalties for your tax preparer

• And in extreme (rare) cases, a tax evasion charge

2. You Claimed Huge Charitable Donations (That Don’t Add Up)

We love generosity. The IRS loves math. If your donation numbers are way out of proportion with your income — like donating $60,000 in used clothes on a $100K income — that’s a problem.

Goodwill provides a valuation guide. Use it. Keep detailed receipts. And remember:

• Donations over $500 require extra documentation

• Special assets like conservation easements or charitable remainder trusts come under heavy scrutiny

I don’t handle advanced giving strategies like CRTs, but I do work with a trusted team of professionals who do. They bring lawyers, documentation, and experience dealing with audits — because no one looks good in IRS orange.

3. You're Misusing the Home Office Deduction

Yes, you can deduct a home office — but only if it’s used exclusively for business. If your office doubles as the family game room, homework center, or Netflix theater, it doesn’t qualify.

Also:
If you're an S Corp or C Corp owner and you're also an employee, you need an accountable plan in place to reimburse your home office expenses. Charging your business rent? That can create passive income and limit your deductions.

Sometimes, trying to DIY this stuff just isn’t worth the audit risk.

4. You Own Crypto and Didn’t Disclose It

There’s a reason the crypto question is front and center on your tax return — right after your name and before your income. The IRS is serious about knowing whether you’ve bought, sold, traded, or received any kind of digital asset.

Even something as small as your friend Venmo-ing you in crypto to pay for lunch counts. If you say “no” when the answer is “yes,” that’s considered lying. And the IRS has ways of finding out.

You probably won’t go to jail, but lying on a tax return is still a terrible idea.

5. You Report Rental Property Losses Year After Year

One bad year on a rental? Fine. Multiple losses in a row? That’s a red flag.

If it looks like you’re running rental properties just to rack up deductions, the IRS may assume you’re not in it to make a profit — and may start disallowing deductions.

Tips to avoid problems:

• Keep separate bank accounts for each property

• Use LLCs where appropriate

• Track income and expenses carefully

• Evaluate whether the property is actually profitable or just draining your bank account

Final Thoughts (and a Quick PSA)

Most IRS audits can be avoided with good documentation, clean bookkeeping, and a little foresight. If anything on this list made your stomach drop, take it as a sign to clean things up now — before the IRS comes knocking.

Need help getting audit-ready (or staying that way)? That’s what I’m here for.

👉 Reach out at RatliffAccountingTax.com
Let’s keep the IRS out of your inbox — and your life.