Unincorporated businesses, or sole proprietorships, are a popular business structure for entrepreneurs just starting out. However, the unincorporated business owner must be aware that the IRS will specifically mark their company for tax audits. This is because, typically, unincorporated businesses fail to accurately keep up their records, often failing to have a separate bank account, or even to retain a proper business license. They are sometimes not state registered, have no payroll, and oftentimes report earnings on a personal rather than business tax return.
Unfortunately, these tactics add up to a company that is very vulnerable to being sought out by the IRS for a tax audit. It is likely that missing receipts, faulty deductions and unreported income will make the company vulnerable to serious tax infractions. The IRS is aware of this and fully admits to seeking these businesses out. In fact, only 10 percent of all audited companies are incorporated businesses. It is far more lucrative to pursue those which are less likely to be financially organized.
Options for Incorporating
The obvious solution is for unincorporated businesses to step up and incorporate, either by choosing a flow-through S Corporation, or go for LLC status. It is unlikely that an emerging business will to be immediately classified as a C Corporation. Advantageously, an LLC has more protection for assets, although it is best to avoid any lingering risk of being audited by choosing to add S Corporation status to the LLC. It is indeed possible to avoid being audited, if one knows how to work around the system.