According to a IRS statistics, those who incorporate their business is 10 times less likely to be audited than those who run a business and report that income on a Schedule C form. Schedule C is for sole proprietors who report that income directly to their personal 1040 tax form.
Now, correlation does not equal causation. That is for certain. So all we can do is guess as to why this is. Is it possible that the IRS algorithm’s feel that those who report income on the Schedule C are more likely to hid income, or take inappropriate deductions? It’s possible. Also, is it harder to do these things when the Corporation must file its own tax return? That is also highly possible.
When you incorporate your San Diego small business, you will most likely elect to tax the corporation under Subchapter S. This makes it a separate entity. You must file a tax return for the Corporation, then report the results of that onto your own tax return. Most of this must be done by an accountant or CPA. It is therefore not an unreasonable assumption to believe there is less risk of abuse here, although the risk still remains.
Oh and you also get increased asset protection as well. Not a terrible side effect.
Small businesses are the IRS favorite targets. They are ripe for abuse. Unnecessary deductions, excessive deductions, hidden income here and there. Sure why not, who is counting anyways.
So as a small business you must do your best to keep a low profile from the IRS so you don’t risk being on the receiving end of an audit. According to figures from the IRS, rates of audit for Schedule C filers can reach as high as 3.68%. The rate for Corporations under Subchapter S? 0.30%.
That is amazing and quite surprising to see such low rates of audit.
So whether it’s causation or just plain old correlation, it appears that incorporating your business may lower your audit risks substantially.
