Surviving (and Maybe Avoiding) an ATO Audit: Practical Guidance for Small Business Owners

For many self-employed Australians and small business owners, the idea of an ATO audit can spark nerves — even when you’re doing everything right.

Tax obligations can feel complex, the rules change over time, and it’s easy to overlook something when juggling cashflow, customers, staff, and the realities of day-to-day business life. But understanding how audits work, why the ATO selects certain cases, and what you can do to protect yourself can make all the difference.

The ATO actively monitors small business compliance and uses sophisticated data analysis, industry benchmarks, bank information, lifestyle indicators and even community “dob-ins” to identify cases for review. While this may sound intimidating, the goal is simple: to ensure all assessable income is declared and only legitimate business deductions are claimed. For most businesses, staying on top of your records and understanding how the ATO thinks is enough to avoid problems altogether.

If you’re self-employed, a sole trader, a contractor, in a partnership or running a small company, knowing how to minimise audit risk — and how to survive one if it occurs — is essential. Cash payments, lifestyle mismatches, incomplete records, unexplained bank deposits, and poor separation of business and personal finances are some of the most common issues that trigger audits or make them harder to defend.

In this guide, we break down the key audit risk areas, explain what actually happens during an ATO audit, and share practical steps you can take now to protect your business.

Cash Jobs – Why The ATO Takes Them Seriously

Offering a discount for cash in exchange for not reporting income might seem harmless, but it’s one of the biggest red flags for the ATO.

Cash jobs signal:

• A potential intention to underreport income
• A lack of accurate documentation
• A pattern of off-the-books activity

While still common in some industries, they come with significant risks — especially if a client relationship sours. A disgruntled customer can report the behaviour directly to the ATO via its confidential “tip-off” line, which is a frequent source of audit leads. In many cases, this is all it takes for the ATO to initiate a review or audit.

The safest approach is simple: avoid cash jobs altogether. If you must accept cash, always issue receipts and record the income properly.

Industry Benchmarks – How The ATO Detects Anomalies

The ATO maintains extensive industry benchmarks covering:

• Gross profit margins
• Expense ratios
• Cost of goods sold
• Net profit as a percentage of turnover

These benchmarks are based on data from thousands of businesses across Australia and help the ATO identify businesses whose results fall outside normal ranges.

Below Average Numbers

If your numbers fall below these averages, the ATO may ask questions.

But being below benchmark doesn’t automatically mean you’ve done something wrong. It may be due to:

• Illness (yours or a close family member’s)
• A long break from trading
• Poor location or reduced foot traffic
• Competition from nearby businesses
• Inefficiencies or lack of experience
• Declining industry conditions

Understanding where you sit relative to your industry — and having clear explanations ready — can help you feel more confident if the ATO makes an enquiry.

Lifestyle Indicators

Does Your Spending Match Your Income?

Another method the ATO uses is comparing a taxpayer’s lifestyle with the income they’ve reported.

Red flags include situations where a low reported income does not appear to match:

• Expensive overseas holidays
• High-end vehicles
• Significant home renovations
• Children attending private schools
• Luxury purchases such as watches or jewellery

If your disclosed taxable income could not reasonably support your lifestyle, the ATO may investigate whether you have unreported income or undeclared cash flow.

This doesn’t mean you can’t enjoy financial success — it simply means you should ensure your income reporting accurately reflects your capacity to fund your lifestyle.

What Actually Happens During An ATO Audit?

If the ATO believes your taxable income may not be correct, it has the power to issue a default assessment based on its own calculations. These assessments are usually based on:

• Bank account analysis
• Estimates of private spending
• Business benchmarks
• Third-party data

A key point to understand:

The ATO does not need to prove precisely where undeclared income came from. If bank statements show unexplained deposits, the ATO can treat them as income unless you can prove otherwise.

This is where incomplete or poorly organised records can become costly.

The challenge with missing records

Taxpayers without accurate financial records often face:

• Double counting (e.g., the same money treated as both income and private spending)
• Inability to explain deposits or withdrawals
• Difficulty proving legitimate deductions

To overturn a default assessment, you must prove:

1. The ATO’s estimate is wrong and
2. What your correct taxable income actually is

Many taxpayers fail on this second point, meaning the ATO’s assessment stands — often leading to very large tax debts.

How To Protect Yourself Before An Audit Ever Happens

The best defence against an ATO audit problem is prevention.

These practical steps can significantly reduce your risk:

1. Keep business and personal accounts separate

Mixing the two is one of the biggest audit pitfalls. Separate accounts keep your records clear and easier to defend.

2. Avoid using cash for business transactions

Cash makes it harder to verify income and expenses. Where possible, use electronic payments.

3. Never run personal spending through the business

This is one of the clearest indicators of poor record-keeping and can trigger adjustments.

4. Keep evidence of non-taxable receipts

This includes:

• Loans
• Gifts
• Transfers between your own accounts
• Inheritance payments

Record them at the time they occur.

5. Be ready to explain lifestyle factors

If you enjoy a higher standard of living than your taxable income might suggest, have documentation to support how it is funded (e.g., loans, savings, an inheritance, or your partner’s income).

6. Consider voluntary disclosure

If you realise you’ve made a mistake, making a voluntary disclosure before an audit formally begins can significantly reduce penalties.

7. Maintain complete, accurate business records

This includes:

• Books of account
• Receipts
• Bank statements
• Invoices
• Reconciliations

Good record-keeping is the single most important protective measure.

Wilson Pateras & Your Tax Accounting

An ATO audit doesn’t need to be a nightmare — but it does require preparation, organisation and honesty. Most issues arise not from deliberate wrongdoing, but from poor systems, forgotten records, or misunderstandings about what needs to be reported.

By understanding how the ATO identifies audit cases and putting strong financial habits in place, you can significantly reduce your risk and ensure you’re ready if the ATO ever takes a closer look.

At Wilson Pateras, we work closely with self-employed professionals, small business owners, and contractors to ensure their tax affairs are accurate, compliant and audit-ready. Whether you want to strengthen your record-keeping, review your deductions, or need assistance responding to an ATO review, our experienced team can guide you every step of the way.

Get in touch with our team, and we’ll help you protect your business, stay compliant and reduce the stress of dealing with the ATO.