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Your Worst Nightmare: An IRS Audit



Your business is growing and you are prospering. Business is good. Life is good. Then the unbelievable happens, which turns your world upside down and pushes you into pure panic.

This panic mode is instantly brought on by receipt of an IRS audit letter.

Most of us don’t fear something exploding or catching on fire as much as we fear an IRS audit. Of course, the best way to survive a tax audit and even to come out of it successfully is not to panic, but to prepare.

Take it seriously.

Even though IRS audits are fairly routine events, they should be taken with the utmost of seriousness. In the event you receive an audit letter, you should immediately spring into action to ready yourself for the audit. The IRS usually sets the time and place for the audit. If you try to put it off, any penalties and interest will just become that much bigger. If you choose to represent yourself, you should adjust your schedule to comply with their date. Think of not showing up for an audit the same as not showing up for trial in a courtroom. It is that serious.

The really, really bad news.

If you think there is nothing worse than you getting from the IRS than a standard or routine IRS audit letter – continue reading …

You can be investigated by the IRS through a civil tax audit (which is very serious) or through a criminal investigation (which is even more serious). The criminal investigation arm of the IRS can come bearing badges and guns, as it is an investigation of fraud against the United States government. In any such investigation, the IRS can (and probably will) obtain your bank records and other financial records, both business and personal.

Virtually all small businesses involve close ownership with profits or losses going ultimately to the business owner. This is why the IRS looks closely at your personal accounts. Any instance of depositing unreported income in a bank account will probably show-up in an IRS audit. Small businesses which prepare their own tax returns (as opposed to going through a tax professional such as a CPA) are more likely to be audited.

Why does the IRS exercise extra scrutiny over small businesses?

The IRS especially scrutinizes the self-employed because the agency claims that most tax cheating is done in small businesses. There is some logic to this because, in a self-employed business, there are many more opportunities to blur the difference between business expenses and personal expenses. Also, many self-employed people put the idea of proper record-keeping and the cost of hiring accounting and tax professionals at the bottom of their priority list. It is not uncommon for business owners to concentrate more on the operational side of the business than to properly accounting for the true business expenses and deductions.

It is a statistical fact: Self-employed individuals are much more likely to get audited than regular employees.

What the tax man looks for.

A tax auditor is looking for certain things when they audit you and your business. The IRS training manuals note that the auditors are examining you and not just your business tax return. Your lifestyle may be checked against your reported income to see if there is a discrepancy which shows skimming, diversion of funds or deception. For example, that mansion with the truck-mount van parked out front may send up the wrong “economic reality” flag.

Travel and entertainment deductions in a business are usually suspect as some people try to deduct personal entertainment and meal “business” expenses. You must be able to clearly explain the business relationship in a credible fashion. Taking your friends out to the ballpark or taking the family on a vacation to that industry conference may not quite pass the litmus test of an audit. Writing off your legitimate business entertainment expenses requires detailed explanation of the reason for the expense, as well as a receipt.

Your calendar will undoubtedly be scrutinized to make sure there are no glaring gaps between possible work, vehicle or equipment usage and the income reported. As an example: If you are claiming 100% business vehicle usage but your calendars do not confirm the times and locations of service stops, you may be open to an analysis of possible personal use of the vehicle. Entries in a business diary or calendar help to justify an expense to an auditor as long as it appears to be reasonable.

Business credit cards are also highly scrutinized as they have a high potential for misuse (such as use for a personal vacation or personal expenses). Keep these only for legitimate business expenditures (places where company checks won’t do). Too many times a small business owner says that they will “reimburse the business later” for that personal expense put on the business card. That routine just opens you up for closer inspection.

Don’t Take The Chance And Lose Everything You Have Worked For.

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation.

Original Post By:  Jeffrey Kahn