Surviving a Business Audit

Introduction

RS sends an audit notice demanding an extensive list of records, none of which you have.

Terror strikes and you think to yourself: Am I going to jail? Will I be wiped out financially? Did they find out about those under-the-table payments? If I had known how frightening this is, I would have kept better records

So now’s your chance.

Audit Prevention

Here are several basic steps to protect yourself when the tax man comes knocking:

1. Use a separate credit card and bank account for your business. Do not co-mingle (mix together) your personal and business income and expenses. Always deposit your business income into your business account, never into your personal bank account. Transfer funds from your business to your personal account when you need money.

2. For each tax year, purchase an accordion file with monthly slots and place invoices, receipts and bank statements in the appropriate slot. Label the file with the year.

3. If you deduct automobile expenses, notate either a paper or electronic calendar each time you travel on business. Record the client, location and purpose of the travel. Deduct only the portion of the expenses actually used for business.

4. If you claim entertainment expenses, pay by business credit card and jot down on the receipt: the client, his or her company and the purpose of the meeting. Note this information in your calendar as well. When you receive the monthly credit card statement, staple the notated receipts to the statement, or record the information from your calendar or receipts on the statement.

5. When determining your gross business income, make sure your business account deposits correspond to your paid billing invoices and account for any cash received, checks deposited into your personal account or checks cashed by a third party.

During an audit, IRS may compare these amounts and if unreported income is discovered, expect a penalty in addition to the taxes and interest owed. If the discrepancy is large, consult with a tax attorney immediately, as this might lead to civil fraud or even criminal charges, depending on the circumstances.

6. If you are paying workers as independent contractors, make sure you know the rules and comply with them. You should have a written contract. Obtain a Form W-9 from the worker, pay by check (note the project in the memo section) and issue an Form 1099. However, if an individual is really an employee, do not try to classify the person as an independent contractor, otherwise, you are inviting big trouble.

7. To minimize the tax consequences of an adverse audit, timely and fully pay your quarterly estimated taxes, or overpay and apply any refund to next year’s estimated taxes. Be sure to file your Form 1040 on time, or request an extension.

Remember, the failure to file penalty is generally 10 times higher than the failure to pay penalty – so file timely, even if you cannot fully pay your taxes.

Conclusion

Take these common-sense steps now to prevent a potential tax disaster. Record your business income and expenses using accounting software, such as Quickbooks, and work with a bookkeeper to set up your account systems correctly from the start.

If this sounds like too much trouble, imagine when the IRS comes knocking at your door and your reaction of sheer panic.

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