Say the word “audit,” and small business owners run for cover. Nothing generates as much fear as the prospect of having to come before the IRS and defend a businesses’ tax records. Even if everything is in order, the audit process is stressful, time-consuming and costly.
But what are the chances that your business will be audited? Apparently, no one knows for sure exactly what triggers an audit. But at Fox Business’s Small Business Center, tax expert Bonnie Lee says there are some red flags. About one percent of personal returns are audited, but the odds increase with business returns, especially as your business income rises.
Some business returns are chosen randomly for audits; others are hand selected. A few of the obvious tip-offs that can cause the IRS to flag your return:
- Your income doesn’t match the 1099 totals;
- You exceed the IRS’s industry standards for average expenses;
- You have big numbers in categories like travel, meals or entertainment; and,
- You prepared the return yourself
The tax code isn’t getting any simpler and changes all the time. To keep your ducks in a row (and the IRS away), consult periodically with an attorney and tax professional to make sure you’re not only minimizing your audit risk but also that you’re taking full advantage of potential tax rates.
But even with sufficient attention to tax detail, a certain percentage of small business tax returns will be audited. If you’re among these, the legal site nolo.com advises business owners to first, don’t panic. Second, prepare, prepare, prepare. Much of this advice is common sense.
You can go it alone, the site says, but who would want to? Wouldn’t anyone benefit from having their tax professional/preparer with them through the audit process? Anyway, preparation is much the same either way. Review your returns being audited and make sure all the figures can be substantiated. Ideally, you have plenty of documentation, including receipts, checks and any other items that apply. The IRS will want to see all of it, so make sure everything’s organized and logical (This is the IRS, after all).
Lee stresses neatness, too, because it will help streamline the review process and builds your credibility in the eyes of the IRS. If you have good records, agents are more likely to give you the benefit of the doubt. But the opposite is true if they have to dig through messy records.
It’s a no-brainer that the IRS wants written documentation of your expenses. But they can accept verbal explanations, too. If you get an audit notice, there should be a list of what documents to bring to the audit:
- Bank statements, cancelled checks, receipts. You can also use hand-written notes or a notebook if you paid for some things in cash.
- Electronic records, such as credit card statements, with the name, date, amount and address of each payee.
- Books and records. Small businesses aren’t required to keep formal books. But the IRS will want to see whatever you do have if you don’t keep ledgers and journals—pc/printout, checkbook register or cash register tapes. Without these, the IRS can estimate and even impose extra penalties.
- Calendars, appointment books, logs. Believe it or not, this can help justify your expenses.
- Records for listed equipment (for both business and personal use). Cell phones, cars and computers are the most common.
- Other documentation:
- Auto records: Mileage log, gas and repair receipts
- Travel and entertainment: If you’ve kept an appointment book or log and copious notes of your activities and expenses, yay. Otherwise, put together the best documentation you can. BUT—don’t try to fudge it or fool the IRS, Lee says. You’ll lose your credibility, and it’s downhill from there.
- Record of business rental expenses
If you find yourself among the to-be-audited, CNN Money says there is a small bright spot. Now small business owners, like their mid-size and large counterparts, can file for a fast-track settlement, meaning that it can all be settled in 60 days. Plus, the site says, furloughs and budget cuts at the IRS have resulted in declining audit rates!
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