Audit Defense Trick: Incorporate!


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5-25-1D/B/A. Sole Proprietorship. Schedule C. Unincorporated Business. These are all different words for what is probably one of (if not the) most common business structures for beginning business owners. But there’s another term you need to get familiar with, too. Audit Target.

When you’re an unincorporated business, life is easy. You want to be in business – bang! You’re in business. You do business in your name, or maybe you file for a d/b/a and do business under a name. You may or may not have a business license, a separate bank account, and so on. But you aren’t registered with the state, so no annual reports, no payroll … there just isn’t a lot of work involved. At the end of the year, you add up your income, add up your expenses, and report the money on your personal tax return.

5-25-2The IRS loves businesses like yours. Why? Because they’re easy targets. The lack of serious recordkeeping means there’s a great chance you’ll be missing some receipts, or will have taken too many deductions by mistake. Or, maybe you made some extra money that you didn’t properly report. There are plenty of options.

The IRS admits it targets unincorporated businesses much more than incorporated ones. The ratio is about 10 to 1. So for every 10 sole proprietorships that get audited, only 1 incorporated structure is chosen. As they see it, that’s where the low-hanging fruit is.

When you put it that way, the simplest way to reduce your audit risk is simple: incorporate. Create a corporation that elects flow-through S Corporation Status (chances are you won’t need a C Corporation when you’re just starting out). Or, create an LLC instead. I like that structure better for asset protection. But make sure you elect S Corporation status in your LLC, too. Otherwise you’ll get asset protection, but you won’t lower your audit risk.



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