Perhaps you've been thinking about making a change
in your Choice of Entity. Maybe you've been asking,
"What type of Business Entity should my business be?"
By "Business Entity", I mean the legal structure
of your business, and there are basically
five from which to choose:
Limited Liability Company (LLC)
This is not a question that is easily or quickly
answered. There are many factors to consider,
and here's one that is often overlooked:
If you are a Sole Proprietorship, your odds of getting
audited are two, three or even four times greater
than the other entity types.
Take a look at the following chart of IRS audit
rates for Year 2002:
INDIVIDUALS -- with Schedule C
< 25,000 ................ 2.63%
25,000-99,999 ........... 1.13
> 100,000 ............... 1.36
< 250,000 ............... 0.22%
250,000 - 1M ............ 0.73
S CORPORATIONS .......... 0.42%
PARTNERSHIPS/LLCs ....... 0.27%
Now let's analyze the numbers by comparing
the Schedule C audit rates with those of the
other entity types. Do you see the difference?
Depending on your sales, the audit rates for
Sole Proprietors range from 1.13% to 2.63%,
compared to the rates of 0.22% for
small "C" Corporations, 0.27% for Partnerships
and LLC's, and 0.42% for "S" Corporations.
Of course, all these audit rates are still
relatively low, especially compared to previous
years. And even at 1 to 2%, I hope you like the
odds of not getting audited.
But if you are looking at the pros and cons
of incorporating your Sole Proprietorship,
you should be aware that making a switch
will improve the odds in your favor even more.
Should you form a corporation simply to lower
the chances of being audited? Of course not.
But if there if have other compelling reasons
to incorporate, these lower audit rates are
the icing on the cake.
NOTE: The above statistics are taken
from an Excel spreadsheet freely available
at the IRS website. This spreadsheet shows
audit rates for all types of returns for
years 1996 through 2002.