As the year winds down, many farmers and small business owners start turning attention to the end-of-year tax planning.
End-of-year tax planning is a great time to crunch some numbers and see if it pays to follow through with plans before the turn of the year to scoop up deductions, or wait a bit a longer. At the same time, fall is an opportune time to make sure your financials are complete and accurate, so you’re not scrambling to fill in missing data at tax time.
According to the IRS, an audit is a formal review of a tax return to verify everything was reported accurately. Though rare, or perhaps because they are rare, audits can be an alarming event for any entrepreneur.
What types of small business tax audits are there?
Letter audit
This is where the IRS sends a letter requesting further data, because what you reported conflicts with data reported by a third party, such as your bank, someone you did business with or a government entity. What they want is further documentation or some explanation on why the record differs from what you reported.
In-person audit
This is where the IRS notifies you of an in-person audit, and it’s because they noticed a major discrepancy on your return — most likely something that was on a larger scale. Thus, they’ll request an audit with you, so you can provide the data and evidence they’re looking for to back your claim.
Some businesses are selected at random, so if you are chosen, it may just be your turn.
Whatever the reason for the IRS audit, it’s a smart idea to hire an accountant or CPA to help you understand the process and bring the issue to a resolution.
The IRS can also conduct an audit based on information reported to them by a third party. Whether this person’s concerns are legitimate or unfounded, keeping everything above board and by the book is the best way through this process.
Bottom line, think of an audit as the IRS asking you to show your work. The best way to avoid hassles with the IRS is to do it right the first time: No dodges, no gimmicks from someone’s “innovative” tax-saving methods, no shortcuts.
What triggers an IRS audit?
When it comes to an IRS audit, it’s important to avoid the patterns of behavior and record-keeping that can raise suspicions.
Another thing the IRS is looking for is the blurring of the lines between personal and business expenses. If you’re a farmer or a sole proprietor, it’s important to be diligent with your financial records, so you don’t inadvertently trip off alarms at the IRS.
Too many round numbers
It’s common practice for a business to estimate and round up. But if the IRS notices a pattern of too many zeros in a line item — especially to the nearest hundredth or thousandth place — that’s considered red-flag accounting. The IRS will want you to dig deeper to find the data that backs up your estimates. It’s a matter of doing it right the first time.
Math errors
A miscalculation or transposed number can set off alarm bells at the IRS. So can other errors, such as failing to enclose a form or not signing your tax return. Sure, to err is human. But if the mistakes hide or misrepresent your financial picture, the IRS would naturally want to confirm them.
Too many write-offs
Home office, travel, meals and vehicles are all legitimate business expenses. But when you, as a solo entrepreneur, claim 100% business use on your vehicle, that’s a red flag to the IRS. To keep things on the up-and-up, track your mileage and log the purpose of your business-related trips so you can provide a record.
Of course, keeping your receipts and maintaining a log of other business-related tax write-offs can ensure you’re reporting things accurately and can stand up to scrutiny by the IRS.
Excessive use of independent contractors
The IRS is aware of the fact that hiring independent contractors vs full-time employees can net real savings in expenses, such as unemployment insurance and state payroll taxes. If someone reports that you have misclassified your workers, that can trigger an IRS audit.
Claiming losses for several consecutive years
No one expects that every business will have year after year of profits. But multiple years of reported losses can get attract IRS attention because they’ll want to confirm you’re reporting deductions properly. Another thing they’re watching out for is using hobby expenses to claim a business loss.
Going through an IRS audit can be time-consuming and stressful. But as we indicated earlier, the main objective is to confirm and verify that what you represented on the tax forms is accurate. Hire an accountant or CPA, preferably one with subject matter expertise in your field — someone who knows the minefields just as well as the deductions — and take extra time to keep your records in order. It’s a hassle, but you don’t want to pay more than you have to — or get pinged with fines and back interest for stretching the truth.
While you’re planning for end-of-year taxes, now’s a good time to perform a self-audit of your financials, and make sure you're using the right tools.
Get to know Minnwest Bank’s cash management tools to help you manage your money safely and efficiently. Talk to a cash management specialist to help your business run more efficiently and keep your records in order.
Set up an appointment today with a cash management specialist at Minnwest Bank!
