Know How: The IRS Man Cometh
Tips for small business owners dealing with the stress of an audit
By Mary Ellen Hall
Special to the Worcester Business Journal
It can be all the more taxing, however, if the Internal Revenue Service comes knocking on your door.
Small Targets
Small businesses, especially sole-proprietors, are at greater risk of being audited because the IRS believes, rightly or wrongly, that self-employment incomes are grossly underreported.
Unless you have a simple tax return, don't handle the audit by yourself. Send a seasoned tax professional to the audit instead. In addition to the paperwork, the auditor will be looking you over during the audit. The IRS Auditor will focus on five fundamental audit issues: your financial lifestyle; your standard of living and reasonableness of business operations costs; your spending habits and new purchases (conspicuous consumption); bank deposits and whether you reported all income from 1099 or W-2 reports.
If these factors don't match your tax return (or industry standards), the IRS will suspect unreported income or inflated expenses. IRS agents are highly skilled detectives who utilize the latest electronic tools and information sorting technology to know much more about you, your business, and your lifestyle than you would suspect. Remember, they play this game all day, every day. The average taxpayer may only face one audit during a lifetime, and is often not ready for what he or she is up against.
If you are audited, there are some steps you can take to make the process a little less painful, and a little more favorable to your bottom line.
First, act professionally during the audit. Ideally, you'll let the agent conduct the audit at your accountant's office, without you present. If you do meet with the agent, be polite and answer truthfully. If you don't know the answer, say so. For your own protection, keep all answers short and to the point. Don't be led into discussions where you could say something that is misunderstood or causes the agent to expand the audit.
Dot I's And Cross T's
Also, document revenue. Many of the audit techniques are focused upon finding unreported income. You should have a separate business checking account, even if you're a sole- proprietor. All receipts should be deposited promptly in the bank. Clearly mark any shareholder or other loan proceeds as such, since the IRS will assume all deposits are revenue.
The government is more likely to investigate cash-based businesses, so make sure your accounting is tight. Cash transactions of more than $10,000 need to be listed on Form 8300.
If you've kept good records of income, expenses, debts and deductions, the professionalism will show on your returns. Experts advise keeping records and receipts for at least seven years.
Remember to accurately assess independent contractors versus employees. The IRS is reportedly on the lookout for business owners who qualify employees as independent contractors, so be sure to classify workers properly.
Watch your professional/personal deductions. The IRS doesn't like business owners to mix the personal and the professional when it comes to write-offs. And be prepared to explain big deductions.
And finally, file complete forms. The IRS is forced to take a second look if you leave parts of your schedules or returns blank
Mary Ellen Hall is an enrolled agent operating out of Auburn.
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