How to lower your audit odds
by Daniel Kehrer
Odds are slim that the IRS will audit your business taxes. If
you’re honest and keep good records, there’s not
much to worry about. That’s the good news.
Now the bad: Audits are up. Way up. And who is most likely to
be audited? Sole proprietors — the most prevalent type of
small-business ownership. All those deductions your business is
legally allowed to take can also trigger IRS flags. Sole
proprietors are at least 10 times more likely to be audited
than other business entities.
But wait. There’s more good news.
The IRS lacks enough people-power to scrutinize every tax
return, or anything close to it. So they target those they
believe will yield the most payback in taxes and penalties.
That means there are concrete steps you can take that will
lower (though not eliminate) your chances of an audit.
The reason is something called a DIF score — gov-speak
for Discriminate Information Function. This is the secret IRS
formula that decides if you’ll be audited or not. And
while the details of DIF (and UI-DIF, which sniffs for
unreported income) are hush-hush, these simple steps can help
you avoid the audit hook:
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Be accurate, thorough, neat
and on time (but not early). Sloppy returns, math
errors and rounded numbers raise flags. Using tax preparation
software is a great way to make your return look
professional. And the software helps you avoid mistakes. File
on time, but filing early only gives the IRS more time.
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Do not file
electronically. The IRS hires temps to enter data from
millions of paper returns, who absorb only about 40% of the
information. Electronic filing gives the IRS easy access to
100% of your return.
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Be honest.
Every year, the IRS gets better at using technology to track
down your business income. And some things are just obvious.
If you claim lots of expenses, but show little revenue to pay
for them, the tax folks get curious.
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Explain
yourself. Avoid vague expense categories, such
as “miscellaneous.” And if your business is
claiming unusual deductions, provide some explanation or
documentation.
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Make your quarterly tax
payments. It is vital to make them on time and
to not underpay. Late payments, non-payments and
underestimated amounts draw IRS attention.
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Beware your
income-to-deduction ratio. You are more likely to be
audited if the difference between your expenses and income
exceeds 52%. Watch out for abnormally large deductions.
It’s not just the total amount of deductions
that’s important. A single large deduction can also
increase your audit chances.
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Form a corporation or other
business entity. To avoid the higher risk of
sole proprietor audits, consider making your business a
corporation or limited liability company (LLC).
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Hire a tax pro.
If your return is complex or you are uncertain about
treatment of deductions, income or other areas, don’t
hesitate to bring in a CPA or other business tax pro. The
money will be well spent.
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Beware the home office
deduction. It’s a prime IRS target, so if you
plan to use it, make sure you know the rules. IRS Publication
587, Business Use of Your Home, can help.
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Sign it! Simple, but
so often forgotten. And all it does is call attention to your
return.
— Daniel Kehrer, BizBest
Media
RESOURCES:
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If your business issues 1099 forms, W-2s, 941s or related
forms, a terrific place to do it fast is Filetaxes.com. Open
an account and have your forms out in minutes.
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CCH Tax & Accounting is a top supplier of tax information
and software to small business. Their CCH Business
Owner’s Toolkit is an excellent resource. Visit www.toolkit.cch.com.
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TurboTax is a popular line of tax preparation software from
Intuit (which also makes Quicken). Visit www.turbotax.com.
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To download IRS Publication 587, Business Use of Your Home,
or other IRS publications, go to www.irs.gov/publications.
The IRS small business website is easy to navigate and covers
every tax topic you can think of. Visit www.irs.gov/smallbiz.
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A tax professional can help you face an audit. CPAdirectory.com lists
450,000 CPAs nationwide. Searchable database helps locate
CPAs by name, location, specialization and industries served.
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