How Often Do Businesses Get Audited? Factors and Rates

The Internal Revenue Service (IRS) conducts audits to ensure compliance with tax laws, verifying the accuracy of information reported on tax returns. While audits are a mechanism for enforcement, they are not widespread for most businesses. The IRS uses data analysis and human review to identify returns with potential errors or underreporting, focusing resources efficiently.

General Business Audit Rates

The frequency of IRS business audits is generally low, though rates can fluctuate based on business type, size, and IRS enforcement priorities. For 2021 tax returns, the audit rate for partnerships and S corporations was approximately 0.1%. C corporations saw a slightly higher audit rate of 0.3%. Sole proprietorships, particularly those filing Schedule C, experience varying audit rates depending on their gross receipts.

For sole proprietorships, those with gross receipts under $25,000 had an audit rate of about 1%, while businesses with gross receipts between $100,000 and $200,000 saw a rate of around 2.4%. The audit rate for those with gross receipts over $1 million was nearly 4%. Larger businesses, especially corporations with significant assets, face higher audit probabilities. For example, C corporations with assets between $5 million and $20 million had an audit rate of 6.5% for 2021 returns, and those with $20 million or more in assets had a rate of 15.8%. These statistics highlight that while overall audit rates are low, they tend to increase with the complexity and financial scale of a business.

Key Factors Influencing Audit Frequency

Several characteristics of a business can influence its likelihood of being audited. Businesses operating in cash-intensive industries, such as restaurants, salons, or car washes, often face increased scrutiny due to the difficulty in tracking cash transactions and potential for underreported income. Proper documentation and meticulous record-keeping are especially important for these businesses.

The complexity of a business’s tax return is another significant factor. Returns with numerous deductions, complex financial structures, or international transactions can draw more attention. Businesses with a history of non-compliance, including past audit adjustments or unfiled returns, are also more likely to be selected for future examinations. The IRS’s Discriminant Information Function (DIF) system analyzes returns for anomalies, flagging those that deviate significantly from statistical norms and may contain errors or unreported income.

Specific Actions That May Trigger an Audit

Certain specific actions or discrepancies on a tax return can act as immediate red flags, significantly increasing the chance of an audit. A common trigger is a mismatch between income reported by the business and information from third parties, such as Form 1099s. The IRS cross-references this data, and inconsistencies can prompt an examination. Overstated or unusually high deductions relative to a business’s income also frequently draw attention, including expenses like excessive travel, meals, or entertainment that seem disproportionate to operations.

Consistent reporting of business losses year after year can also trigger an audit, especially if the business does not show an intent to make a profit. A pattern of continuous losses might lead the IRS to question if the activity is a true business or a hobby. Claiming excessive home office deductions or a high percentage of business use for a vehicle without detailed documentation are other common triggers. The IRS looks for proper substantiation for all deductions, requiring businesses to maintain meticulous records to support their claims.