Victor’s Insider Scoop on What IRS Auditors Look for When Examining a Business …
September 15th, 2009 | top of page

When an IRS auditor shows up in your office be aware that they are there not just to examine your return—they are also there to examine you. If there is a disconnect between your reported income and the perceived economic reality of your appearance and surroundings you can expect the auditor will raise a red flag. Tax attorney and author Fredrick W. Daily states that the IRS is likely to investigate these eight areas when your small business is audited:

(i) Is your reported income congruent with the lifestyle the auditor will infer from your clothes, rings and watch, auto, or office furnishings? If you look like a Wall Street investment banker but have the tax return of a Walmart cashier you can bet the auditor will be sharpening his pencil.
(ii) Do your day–to–day operations involve a lot of cash transactions? If yes, you can expect the auditor to suspect that some of it gets into your pocket before it goes on the balance sheet.
(iii) If you only have one car and you write off auto expenses auditors will not believe that you use public transportation for all of your non–business transportation needs so don’t even think about claiming 100% of auto expenses. And, if you are more prudent and claim a high percentage of business auto use, then your best defense will be to keep a detailed mileage log.
(iv) Travel, entertainment and vacation business expenses are also likely to receive close scrutiny. Be sure to keep records for all claimed travel and entertainment deductions. Going to a hockey game with your brother in law and trying to claim it as a business expense will be scrutinized if you can’t explain his relationship to your business.
(v) If you have unreported business income of $10,000 or more you will need professional help to untangle the mess you’ve gotten yourself into. Your best move will be to hire a professional tax consultant, step back, and let him handle it for you.
(vi) It could get ugly if the auditor discovers what appears to be large amounts of unreported income. The IRS has a criminal investigation unit.
(ii) If you have employees you can count on an audit of your payroll tax returns. Make sure you file quarterly payroll tax returns and make the required tax payments.
(iii) Finally, if you use independent contractors (because of the tax savings compared with true employees) are those people really employees masquerading as independent contractors? Having a high percentage of independent contractors will result in a closer look by the auditors.

Although this is a list of areas most likely to be investigated by an auditor it is not comprehensive. If you find yourself being audited by the IRS be sure to inform your accountant and/or tax attorney and ask them what you need to do to be prepared.

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