Audit-Proof Your Business
Joseph A. Lux, C.P.A., PLLC
October 1, 2017
Small business and self-employed tax returns are more closely scrutinized, and always much more likely to be audited, by the IRS. Audits come in many sizes: correspondence audit, IRS office audit, taxpayer office audit, criminal investigations, etc. Being prepared for an audit is always your best defense.
Accurate record keeping is a fundamental requirement of running a profitable business. Not to mention, it is also required by the Internal Revenue Service. Good records allow you to keep track of income sources and deductible expenses for tax purposes. Today’s cloud based internet technologies allow business owners or CPA’s to remotely handle business bookkeeping, accounting, payroll, and tax filing responsibilities in a fraction of the time and cost of an in-house bookkeeper. In addition, new cloud based receipt retention services allow a business owner to paperlessly retain all business receipts so that they can be conveniently retrieved should they be required during an audit. I call this audit-proofing your business. So, using me for example, as soon as I receive the paid receipt from my waiter for a business lunch, I take a picture of it with my phone and upload it to my business accounting software through the cloud right on the spot. I then throw the paper receipt into the trash. I do the same when I purchase office supplies, etc. The same can be done with digital receipts. I love it! My receipt is now stored along with the check or credit card that was used to pay it. There when I need it, out of sight when I don’t. No paper, no messy files.
In addition to audit-proof books, I suggest that one try to stay low on the IRS audit radar to help avoid an audit in the first place. Below is a list of tips to help small businesses stay low on the radar and reduce the risk of audit:
1. Make your business a “business”, not a hobby. Multi-year losses reported on tax returns raise a red flag with the IRS. Be prepared to provide evidence to them that you are “in business”. To do this you will need to demonstrate that you have been conducting yourself like a business and intend to make a profit. Are you trying to make a profit? Do you have any money at risk to be lost if you do not make a profit? Be ready to say yes and to prove it.
2. Be sure to report all of your income. Amounts shown on your tax return should agree with amounts reported to the IRS by third parties.
3. If your tax returns are prepared by a CPA, be sure to understand exactly what he is doing. Go over it with him. As the owner of the business you are the person who is best qualified to spot errors in the reporting of your income and expenses.
4. Be prepared to be audited. If you keep your receipts, journal your expenses and auto mileage as you incur them, and keep accurate records of your income, you will be able to show that you are not guessing at your numbers. Showing an IRS agent that you have trouble answering the easy questions is an invitation for a more through examination of your finances.
5. Pay estimated taxes. Pay them on time and keep them current.
6. Never ignore notices from the IRS. If the IRS is trying to get your attention, answer them while it is still a polite nod. If they come to your door, you are in trouble.
7. Don’t borrow money from taxes withheld from your employee paychecks. These funds do not belong to you. A simple short term loan from this month’s taxes with repayment next month is tempting when bills are due and cash is short. Do not do it! The penalties are astronomical!
8. The IRS isn’t stupid! They have a pretty good idea of what a reasonable range for your business deductions should be. If your business earned income in the lower range and deducted expenses in the higher range, you are asking for trouble.
9. Don’t try to claim credits that you are not entitled to. Only claim those that apply to you.
And lets not forget, find a reputable CPA who is a seasoned tax pro. He or she can help you to audit-proof your business, avoid the potential minefields, and save some money in the process.