While tax audits of therapists are rare, it’s wise to do everything you can to avoid one.
An IRS audit can be costly and time-consuming. And in the event the IRS finds you reported your income and expenses inaccurately, it could result in hefty penalties.
This article covers seven steps you can take to reduce the likelihood the IRS will audit your therapy practice. But first, what is an IRS audit? And what happens when you’re audited?
What is an IRS tax audit?
When the IRS audits your business, they go through your financial records to make sure that everything you’ve reported on your tax return is true.
If one of your tax returns is going to be audited, the IRS will typically do it within two years of the year you filed. In some cases, they may stretch it up to three years.
If the IRS finds serious errors on your tax return—and suspects fraud—they may go back up to six years.
Typically, a business is elected for auditing automatically by a computer algorithm. The file is then passed to a human being for further review.
The IRS doesn’t release data on precisely what features of a particular tax return will trigger an audit. Some audits are completely random.
However, there are a few red flags the IRS algorithm watches out for:
- If there’s a major discrepancy between two sequential tax years. For instance, if your income increases $90,000 from one year to the next, with nothing else on your tax return changing.
- If you itemize expenses that are uncommon for similar businesses in similar financial situations.
- If someone you regularly do business with has been audited.
What happens during an IRS audit?
If your therapy practice is audited, you’ll get a letter in the mail from the IRS notifying you of the fact.
Once the audit begins, the IRS will send you requests for financial information. About 75% of personal tax audits are carried out entirely through mail.
You may need to meet with an IRS representative in person to answer questions about your business. You’ll receive plenty of correspondence from the IRS before this meeting takes place.
It is extremely rare for an IRS agent to show up at your house or your office unannounced—so much so that, if someone does show up claiming to be the IRS, it’s likely a scam.
How likely is your therapy practice to be audited?
In 2021, the IRS announced that they would increase the number of audits by 50%, with a focus on small businesses.
Don’t let that send a shiver down your spine, though. Even with the increase, audits of small businesses are extremely rare.
For instance, in 2018, the IRS received four million tax returns from business partnerships—and audited just 140 of them. The same year, nearly five million S corporations filed tax returns, and just 397 were audited.
It’s very unlikely you’ll be audited. But there are steps you can take to push that “extremely rare” down as close as possible to “never.”
7 ways you can avoid an IRS audit of your therapy practice
While the IRS will always audit some businesses completely at random—making it impossible to reduce your chance of being audited to 0%—there are some tried-and-true ways to avoid being audited.
1. Double check your math
You can easily draw unwanted IRS attention to your tax return by making math errors. Miss a line item, forget to carry the one, and suddenly, in the eyes of the IRS, you become an object of suspicion.
Also, if your revenue is being reported on other tax forms—1099s, for instance—and it doesn’t match what you report on your business tax return, it raises red flags for the IRS.
Taking the time to ensure all the numbers add up, and that you haven’t made any mistakes—even minor ones—could save you major headaches in the future.
2. Provide extra detail about new expenses
The IRS is on the lookout for business expenses that are out of the ordinary. In particular, if new expenses suddenly appear on your tax return from one year to the next, or a particular expense increases dramatically, the IRS may take notice.
There are perfectly legitimate reasons for your marketing budget to grow 400% in a year, or your home office deduction to double. But the IRS wants to know why. You have the option of including extra supporting documents when you file itemized deductions, and if any of your expenses are out of the ordinary, it’s wise to take advantage of it.
The extra info won’t matter to a computer algorithm. But if your file is flagged and it ends up in review with a human, the extra information justifying your expenses could save you from an audit.
3. Don’t reuse numbers year after year
When you’re filing your own taxes, it’s tempting to take shortcuts.
For instance, maybe you spent about $350 on office supplies in your first year of business. And with your practice growing so quickly, it’s been hard staying on top of bookkeeping, much less saving and organizing receipts. So, for the sake of simplicity, you itemize a $350 office supplies deduction in your second year of business. And then again in your third year, and so on.
Even if $350 is an accurate average cost of office supplies each year, it will raise red flags for the IRS. Business expenses change. Even regular expenses, like rent (which may increase yearly in order to keep pace with inflation) and internet bills (which change as ISPs change their rates) aren’t set in stone.
Make sure you’re tracking your expenses accurately, saving receipts, and keeping up with bookkeeping, so you don’t have to fall back on lazy shortcuts that could cost you time and effort in the long run.
4. Watch out for round numbers
Similar to recurring numbers on your tax return, round numbers can draw the attention of the IRS.
Using the example above, if you save every receipt for office supplies over the course of a year, there’s a chance your total will come to $344.15, or maybe $352.90. But the odds of it coming out to exactly $350 are very low.
Round numbers scream inaccurate recordkeeping. Whenever you can, be as specific as possible.
5. Form an S corporation
According to small business tax maven Mark J. Kohler, converting your sole proprietorship to an S corporation can result in 15x less likelihood your business will be audited.
Besides helping you avoid a tax audit, forming an S corporation can help you protect your assets and lower your tax bill. You can learn more from our article on how to switch from a sole proprietorship to an S corporation.
6. Stay on top of payroll
The IRS is serious about payroll remittances. If you fall behind on remitting taxes from a employees’ wages, or forget to file payroll reports, it will draw unwanted attention to your therapy practice, and could eventually lead to an audit.
This is important even if your business has just one employee: you. When your business is an S corporation, you typically pay yourself as an employee. But just because you’re paying yourself doesn’t mean payroll reporting and remittances are any less important. Staying on top of these tasks is a key part of keeping the IRS’ good graces.
7. Build a good history of compliance
The IRS has a complete history of its interactions with you. That includes every time you filed your taxes late, made errors on your returns, were late paying, failed to respond to official correspondence, and so on.
They also have a history of every time you were compliant—filing and paying accurately and on time, responding promptly to correspondence, and so on.
One of the best things you can do to avoid the danger of an audit is build a history of compliance with the IRS.
A couple tips for building a good history of compliance:
- If you can’t afford to pay your taxes, don’t just ignore them. Instead, get in touch with the IRS to set up a payment plan. This shows you’re determined to be as compliant as possible. It also saves them the trouble of constantly chasing you down for money.
- File your taxes on time, and only apply for a deadline extension when you need it.
If your file shows that you’re on top of your duties as a business owner, and you don’t create extra hassle for the IRS, it reflects well on your business—and could one day save you from an audit.
Accurate, timely filing is a huge benefit to your business—not just when it comes to avoiding trouble with the IRS. Get help from our complete tax season guide for therapists.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post.
Bryce Warnes is a West Coast writer specializing in small business finances.