Taxes

Audit Odds: Are you at risk? Can you avoid them?

SBOCTeam — Wed, 04 Mar 2009 01:27:00 GMT

Some valuable advice on how to avoid an audit and what to do if you can't
By Max Berry

Just how much time the IRS will devote to small business audits in the current financial climate remains to be seen, but one thing is for sure: Small business owners have always run a heightened risk of being audited. Some businesses are more vulnerable than others, but knowing how to best avoid an audit-and how to deal with one if one can't be avoided-will only help you come tax season.

Risk Avoidance
"Self-employed people have always been...audit targets simply because a salaried person has very few deductions, or ways to cheat," says Fred Daily, tax attorney and author of Stand Up To The IRS. With the IRS looking for cheaters, the best way to avoid an audit is, quite naturally, to play fair. Make sure you report all your income, particularly if you run a cash-based business. Dubious deductions will arouse suspicions as well: Be strict about which ones you claim.

Also take note that the IRS is often on the lookout for businesses that categorize full-time employees as independent contractors in an effort to avoid payroll taxes. If your business uses freelancers, make sure you draw up individualized contracts for their services and refrain from dictating the terms of where and when they complete their work for you.

Speaking of categorization, unincorporated businesses tend to be at greater risk of audits than those that are incorporated. "It's historically true that if your small business is in entity form, your audit likelihood is lower," says Daily. "Small corporations can incorporate and operate as S corps or limited liability corps to reduce their chances of being audited."

Be Prepared
Even if you've taken all the necessary precautions to avoid an audit, it never hurts to be prepared. The National Federation of Independent Businesses recommends keeping all records and receipts for at least seven years. "Records are the Achilles' heel of the small business person," says Daily. "Very few-if they're successful-have the time or ability to keep records." For help staying organized, Daily recommends using an accounting software program.

No one who aims to save every receipt for seven years will be successful. Thankfully, the IRS allows you to reconstruct missing records when necessary. Notations made in a business diary or a calendar from the period in question are acceptable substitutes for actual records and receipts. Also use pre-numbered invoices so the IRS will be able to tell that all transactions are accounted for. Hang on to voided invoices for the same reason.

Deductions need to be documented just as carefully as revenue. Home office deductions, for example, are not valid if your dining room doubles as your office. Take a photograph of your (separate) home workspace and keep it on hand in case an auditor challenges the validity of the deduction. Personal vehicles may be used for business, but take great care to record where and why you used them and keep track of exact mileage. If family travels with you on business, none of their expenses may be deducted; if you take a client out for a nice dinner, make sure you save the receipt.

Handling an Audit
Should worse come to worst, and you become the subject of an audit, don't panic. The IRS does most of its auditing by mail. Even if you are audited, chances are you won't come face-to-face with an agent. But if you do, the easiest way to handle it may be to employ an accountant or tax attorney. That is, if you think the reward will be worth the investment. "If you're dealing with six or seven figures, you may want to think of hiring a professional," says Daily.

Or, if the money you'd save by winning your audit is more or less equal to what you'd pay a pro, you may want to go it alone. "If you're confident," says Daily, "I don't think there's any reason you can't handle [the audit] yourself." If this is the tack you choose, organize all your records ahead of time. Being forced to sort through a messy stack of documents will only force the agent to take a harder look at each of them. Always be polite and answer the agent truthfully, but know your rights. Reading IRS Publication 1, explaining the Taxpayers' Bill of Rights, will give you a sense of what the agent is allowed to ask for and what you are allowed to withhold. Buying yourself some time never hurts either. Request a postponement if you need more time to get your records in order.

Whenever your audit takes place, it is never a good idea to host. Holding the audit at the tax office or your attorney or accountant's office is the smarter practice. Daily explains: "An IRS agent may see something [in your office] that raises a question in his mind. Secondly, there's nothing to stop an agent from talking to your employees, and you probably don't want your employees to know you're being audited."

Employing a professional may be a good way to spare yourself such a visit. An attorney or accountant will know exactly which documents you are required to provide and, perhaps more importantly, the ones you aren't. Once you have supplied your representative with the appropriate materials, you may not even have to be present at the audit. You do have a business to run after all.

Seven Year-End Tax Tips

SBOCTeam — Tue, 02 Dec 2008 15:24:00 GMT

By Christopher Freeburn

The autumn leaves are falling, a chill is in the air, holidays are looming, and, for small business owners, it's a good time to think about ... taxes. While no one likes to ponder the intricacies and implications of the Internal Revenue Code, taking the time to do so toward the end of the year can save your business a considerable amount of money come tax time.

So what can you do now?

1. Lower Revenue. Since your tax bill will be calculated on the basis of how much income your company has made during the year, a good way of keeping that bill down is to defer the receipt of as many payments from customers as possible into January. If your business operates on the cash basis of accounting, this can be easily done by simply delaying the mailing of bills for end-of-year purchases until very late in December, or permitting other bills that are due to be paid in January. Not only does this allow you to lower the current year tax bill, but you get to keep the tax due on those funds in the bank, accruing interest, for a whole year. Additionally, your customers will appreciate the added time to pay their bills, especially around the holiday season.

Note, however, that this strategy only benefits you if you won't be entering a higher tax bracket in the coming year. If you estimate that your business will be operating in a higher tax bracket next year, deferring payments until next year may cost you more later. Also, if your business shows a loss for this year, it makes less sense to defer the payments, since doing so only increases the size of your loss for this year and will have no tax impact.

Also note that simply not depositing a check received before the end of the year does not mean that you can defer that revenue to next year. The IRS requires you to include any checks received before December 31 as part of this year's revenue. Failing to do so could result in penalties if you are audited.

2. Make that major purchase. If you are considering a major purchase of business equipment, it's a good idea to do it now, so that the cost can be deducted from this year's taxes. As part of the Economic Stimulus Act of 2008, signed into law earlier this year, the limit on Section 179 deductions for business equipment purchases was raised from $125,000 to $250,000, and the total amount of equipment purchases that are deductible was raised from $500,000 to $800,000. Both used and new equipment qualify for the deduction and you are able to finance the purchase. But any new equipment acquired must be put into use by your business by December 31 to qualify for the deduction.

3. Increase Expenses. You can reduce your tax bill by increasing the amount and number of deductions you take for business expenses like office supplies and office furniture. You can increase the benefit by charging such expenses on your business credit card, which means that-if you make the purchase in December-you get to claim the deduction for this year's taxes, but won't have to pay the credit card bill until next year.

4. Pay Recurring Bills Now. The same applies to bills for business services, like rent, phone service, and equipment leases, which should be paid before the end of the year, even if not due until after December 31. Consider pre-paying for bills that you know you will need to pay anyway like rent. Such payments can be deducted against this year's taxes. Make sure that pre-payments made now won't complicate your cash flow in January.

5. Contribute to a Retirement Plan: If you don't have one, you really should, and this is the perfect time to set it up. Payments made to a retirement plan-401(k), IRA, KEOGH, or SEP plan-are deductible against this year's income. Most retirement plans have a contribution limit.

6. Consult a Tax Advisor. Tax law is complicated. Very few small business owners, outside of CPAs themselves, have the time or inclination to acquaint themselves with the IRS code and the yearly changes made by Congress. Instead of trying to work it all out yourself, you are better off consulting someone who has made business taxes his or her profession. A tax advisor can make certain that your business is not only in compliance with all the relevant tax codes, but is taking advantage of every allowable deduction.

7. Consider the home office deduction. Do you conduct business out of any part of your home? Many small business owners have at least one room devoted to some aspect of their business, whether it is keeping shipping materials in the garage, or a bedroom that has been converted into an office or filing storage space. With so many small businesses operating partially or completely out of people's homes, the IRS allows small business owners to deduct a portion of rent, mortgage payments, utilities, and maintenance for qualifying home offices. The IRS has fairly stringent tests for such deductions, however, and it is advisable to consult a CPA about your particular situation to make certain it qualifies.

Five Tax Filing Mistakes To Avoid

SBOCTeam — Thu, 20 Mar 2008 14:45:00 GMT

By Barbara Weltman

One of the least fun things about running a business is filing your annual income tax return and paying what's owed. As you embark on this task, don't make mistakes that can lead to needlessly overpaying your taxes or, even worse, becoming the target of an IRS audit.

1. Recognize your vulnerability. There is a $345 billion tax gap the spread between what the government actually collects and what it thinks it should be collecting. Much of this, in the IRS's view, is attributable to sole proprietors who underreport their income or overstate their deductions. Be prepared: Report your income correctly (for example, report all income that has been reported to you on Form 1099-MISC) and keep great records to back up any deductions you claim.

2. Classify your workers properly. Another hot issue for the IRS is making sure that businesses treat workers as employees, rather than as independent contractors, if sufficient control is exercised over the workers. If you have the right to tell a worker when, where, and how the work is to be done, likely he's your employee and you must pay employment taxes (e.g., withhold income tax and the employee share of FICA from his wages, pay the employer share of FICA, and pay federal and state unemployment taxes). You can't simply label a worker an independent contractor if the situation makes him an employee. If the IRS finds out that you've misclassified a worker, you can owe substantial back taxes and penalties.

3. Don't overlook deductions to which you're entitled. Most of your expenses in running a business are deductible, but you may need special records and/or receipts to claim them. For example, taking a customer to lunch is deductible (up to 50% of the bill), but you need a receipt and a written record in a diary, expense account statement, etc. showing the name of the customer, where and when you ate, and what you discussed. If you were profitable, you can shelter income in a qualified retirement plan. The contribution is deductible up to set limits (e.g., a maximum of $45,000 for contributions to a profit sharing plan or Simplified Employee Pension, or SEP, in 2007), earnings grow on a tax-deferred basis, and you create a retirement nest egg for your future. Even if you didn't set up a plan for 2007, you have until the extended due date of your return to set up and fund an SEP. Factor in the cost of covering employees, where applicable. If you made, constructed, grew, or extracted something in the U.S., you may be eligible for a special deduction, called the domestic production activities deduction. For 2007, this is 6% of your net income from a qualified activity, which can mean substantial savings for you.

4. Don't overlook tax credits. There is an array of tax credits you may claim to reduce your tax bill dollar for dollar
Examples:

If you started a qualified retirement plan, you can claim a credit of $500 per year for the first three years to offset the administrative startup costs (e.g., educating your employees about their participation in the plan).
If you conducted scientific research, you may qualify for a 20% tax credit for these research activities.
If you hired someone from certain targeted groups, such as a disabled veteran or long-time family assistance recipient, you can claim a credit for a portion of their wages.
If you purchased a hybrid vehicle, you may be entitled to a tax credit, the amount of which is fixed by the IRS. However, no credit is allowed for any Toyota or Lexus hybrid purchased after August 31, 2007.

5. Avoid tax penalties. What a waste of your hard earned money if you owe tax penalties that could easily have been avoided.

File your return on time or ask for an automatic six month filing extension by the due date of your return to avoid late filing penalties (which can be 25% or more if taxes are owed). However, a filing extension does not give you more time to pay what you owe. If you request an extension, be sure to pay as much as you can along with your extension to minimize or avoid late payment penalties.
Don't let your inability to pay your tax bill keep you from filing on time. If you file by the due date (including the extension), you won't owe late filing penalties. You can deal with your tax bill by requesting an installment agreement from the IRS (if you pay in full within 10 days, there's no interest or penalties). If you need more time, you can have up to three years if the balance is no more than $10,000 and you meet certain conditions you'll owe interest but the late payment penalties are cut from 0.5% per month to 0.25% per month. You can also charge your tax bill to a major credit card, but you'll pay a 2.49% convenience fee to the IRS approved processor, plus interest on any credit card balance you carry.
Don't fail to pay estimated tax if you need to. Business owners don't have tax withholding on their profits and can't wait until they file their returns to pay what they owe. For sole proprietors, for example, estimated tax must cover the income tax on net earnings from the business as well as "self employment tax" (to cover Social Security and Medicare taxes). Estimated tax is paid in four installments for the year: for 2008, these payments are due April 15, June 16, September 15, and January 15, 2009 (don't include your first installment with your 2007 income tax return).

Being smart about your company's taxes can have a significant impact on your financial bottom line. If you don't have the expertise to handle this on your own, or the time to use software for this purpose, be sure to consult with a tax advisor as soon as possible.

Barbara Weltman is one of the nation's leading authorities on small business. She is a contributing writer for Inc.com, PINK magazine and New York Enterprise Report, and is a sought after media commentator who has been featured in The New York Times, The Wall Street Journal, The Washington Post, Reuters, Forbes.com, Marketwatch.com, WABC-TV, Fox News, CNNRadio and CNBC.

Prior to relying on any legal, tax or financial advice or recommendations provided herein, you are advised to consult with your attorney, financial adviser and/or tax professional to verify the information provided and to determine the applicability of any federal, state or industry specific laws and/or regulations that may apply to you. Bank of America shall have no liability for legal, investment, finance and/or tax decisions based on the information provided.

The Do's and Dont's When Facing An Audit

SBOCTeam — Fri, 19 Oct 2007 23:52:00 GMT

For most small business owners, finding a letter in the mail from the IRS can suddenly unleash a flood of emotions, from fear to anger to guilt to helplessness, and that's even before you even open the envelope. And among all the possible scenarios that can flash through your mind, discovering that you are about to be - gulp - audited, is for most small business owners, far and away the worst. Instead of panicking when the IRS comes calling, arm yourself with the information you need to get through the process:

DO:

Keep ALL of your small business's receipts back seven years.

Let the IRS know whenever you move. (Use IRS Form 8822.) If you don't, an IRS notice could go to your old address and an audit could begin without your being aware of it.

Wait a couple of weeks after receiving your audit notice to call the IRS and schedule an appointment. And then pick a future date that gives you as much time as possible to prepare.

Organize your papers (and thoughts) ahead of time so you can quickly answer questions.

Make copies of all correspondence you send the IRS.

Avoid giving auditors your original documents at all costs. Instead, ask that he either take notes or make a photocopy of them.

Treat the auditor politely and professionally, and expect the same from them. If an auditor is rude or disrespectful, you have the right to speak to his or her supervisor.

Consider hiring a tax professional as a consultant.

Have reasonable expectations. Nearly 90 percent of audits conclude with a higher tax bill, so an attitude aimed at simply minimizing your financial losses is often the best.

DON'T:

Fail to file a tax return. Ordinarily, the IRS can only examine returns going back three years. But if you don't file, the statute of limitations on that year never expires.

Estimate. Round numbers on your return tell the IRS you're not really tracking your cash

Forget to print out receipts or order confirmations for all your business's online purchases.

Let an auditor come into your business and freely interact with your employees and customers.

Volunteer information or answer questions that the auditor hasn't asked.

Be a pushover. Ask the auditor questions during the audit and insist that he explain the legal reasons behind any problems that he's found.

Tape-record the audit. Even though you have the right, this often causes the auditor to be even more stringent and, therefore, most experts caution against it.

File another tax return during an audit. Instead request an extension. If you do file during an audit, the IRS could expand its scope to include it.

Offer anything to the auditor that could even remotely be considered a bribe

Taking these steps, along with a talk with your tax advisor or accountant should aleviate some of the pressure should the IRS come knocking at your door.