A lot of business owners may not realize that when the IRS audits their business, the auditor is not just examining the business, but as well as the owner themselves. What the business owners don’t know is that even their personal lifestyle may be subject to scrutiny and there are times when they will need to justify not just business expenses, but even certain personal expenses.
What the IRS is Evaluating?
The following are some of the common indicators that IRS auditors have been trained to be on the lookout for when it comes to business and personal audits.
Does your lifestyle match your income – If your income is not proportionate to the things you own or the way you live, then expect the IRS to put use a magnifying glass and look closer. One example would be if you claim on your return that you have little income and a lot of deductions but wear expensive clothes and jewelry, or drive a really nice car. It would be better to dress well but not show off during an audit. It is also a good time to practice humility since asserting power and demonstrating wealth will most likely work against you.
Did you fail to report some business income – Claiming to have simply forgotten to report an income will not cut it, and may cause you trouble and may even land you in jail. Not reporting an income is a criminal act and the IRS has a special team for such audits. You definitely need to hire a tax audit specialist immediately who could handle the audit for you. If you have a really convincing evidence to support your reason for not reporting an income, then present it immediately.
Do you claim a lot of personal entertainment expenses as business expenses – Entertainment expenses are always subject to scrutiny because it is one of the most abused deductions. The IRS knows too well that small business owners may claim a personal dinner or vacation as a business-related expense, but it takes more than just saying that it is a business expense to convince them otherwise—you have to have clear and convincing documentation that the expense was really related to your business.
Do you have a lot of miscellaneous expenses – Avoid listing expenses as miscellaneous on your tax return as much as possible. If there is a lot of claims for miscellaneous expenses, the IRS would be more suspicious and could send a signal that you are careless with your records or you’re hiding something.
Do you have a lot of auto expenses – Some small business owners may be using only one vehicle for business and personal trips. If there are a lot of auto expenses claims in your business’ return, then make sure that this is supported by gas receipts and mileage logs.
Does your business handle a lot of cash – If your business mostly deals in cash, then the IRS will assume that you may possibly be diverting money into your own accounts. To make sure that you are safe in case you become audited, make sure that you keep very clear and organized records of your transactions, receipts or logs.
Does your business use independent contractors – Many businesses have actual employees who they will call as “independent contractors” in order to avoid paying payroll taxes. In an audit, the IRS will ask each of these “independent contractors” what their roles are and who they answer to, who gives them instructions and how much freedom they have, and other things to determine whether they are contractors or actual employees. Getting caught claiming employees as independent contractors would result in penalties, and not to mention a lot of back taxes.
Do your payroll taxes match your reported employees – Make sure that the payroll taxes you pay match the number of employees you have. This is one item the IRS double checks.
Consider Hiring a Professional to Assist in Audits
If you have an upcoming tax audit, you may not be able to deal with it yourself due to lack of time and the stress it may bring, so consider getting the services of a professional. Some business owners may think that hiring a tax professional signals guilt; this is not so. The IRS would at times actually prefer to deal with the professional who knows the audit process.