The most common source of examination risk on a small business tax return may not be an aggressive deduction, but the six-digit industry classification code entered by the preparer. That’s the position of Tax Strategists of America, a nationwide tax planning firm founded by former IRS auditor Carlotta Thompson, which calls the issue the Peer-Set Error.
The error occurs when the North American Industry Classification System (NAICS) code on a business return doesn’t match the taxpayer’s actual trade or business. Returns are scored by automated systems and compared against others filed under the same code. Enter the wrong one, or a placeholder, and the return gets measured against an unrelated industry, where ordinary expenses can fall outside expected ranges across multiple categories at once.
“A construction contractor coded as a consultant will look wrong on every line of the return,” Thompson said. “Nothing on that return is aggressive. It is being graded against the wrong class. The taxpayer did not cause it and, in most cases, has never seen the field.”
Thompson’s focus on classification traces to her time at the IRS, where she was selected for classification detail. That’s the process by which computer-scored returns are reviewed by hand and flagged for examination.
The distinction she draws is between compliance and planning, two things business owners tend to collapse into one. Classification errors and thin documentation are compliance failures, and they drive examination risk. Properly implemented and documented strategies do something else entirely.
A second requirement goes similarly unnoticed: the accountable plan, a written reimbursement arrangement that lets a corporation cover owner and employee expenses like vehicle mileage and home office costs without those payments becoming taxable compensation, provided the arrangement meets IRS requirements.
“I audited a gentleman with the best mileage records I had ever seen,” Thompson said. “Perfect log. Dates, destinations, business purpose, every trip. He still lost roughly $40,000 in deductions because his company had no accountable plan on file. Nobody had ever told him one existed.”
Tax Strategists of America screens clients against a catalog of more than 100 statutory provisions, credits, and deductions. The firm says it has identified more than $139 million in federal tax savings across 3,707 business owners. Those figures are company-reported and were not independently verified. Carlotta Thompson’s recommendation is narrower than any of that. Pull up your most recent business return, find the classification code, and confirm it describes what the business actually does. It takes a minute and costs nothing.
