IRS AUDIT PREVENTION TIPSThere are many ways to reduce your chances of being audited by the IRS. As we’ve discussed in previous articles, the IRS has red flags for certain industries and tax filing behavior. Unfortunately, real estate investors and business owners stand a far greater chance of being audited than their salaried counterparts. In this article we will look at some tips on how you can avoid these red flags:
• Try not to use whole numbers on your return such as $15,000. This can look suspicious and raise a red flag. Always file the exact amount spent.
• Avoid using a Schedule C for your business. This is a huge red flag because business owners can hide income and claim personal expenses as business expenses. If you file as a partnership or S corporation, you will reduce your chances of being audited considerably. Partnership tax returns are the least audited type of tax return. LLCs are usually taxed as partnerships and are a great option as they also offer limited liability and flow-through taxation.
• Home office deductions can raise suspicion, but this can be avoided by filing a partnership or corporate tax return instead of using Schedule C.
• Ensure that your return numbers match the 1099s you receive from your broker, employer etc.. For example, if your 1099 from the broker shows $26,987 in proceeds from stock sales, the proceeds on your Schedule D of your tax return should be $26,987.
Tax returns are flagged for IRS audits for a number of reasons. They can be picked at random, or set apart by discrepancies in the numbers (your clients report $96,709 in gross income but you report only $65,000), or they can contain certain warning signals. Although the IRS doesn’t disclose exactly what signals send up the red flag, here are a few ways to lower your chances of being audited.
STUPID MISTAKES THAT CAN CAUSE AN IRS AUDIT
Mistake #1: Selecting the wrong business type for your business.
There are some basic rules when it comes to selecting the right business type for your business. Don’t put appreciating assets inside a corporation. There are a few (very few) instances where you might need to use a corporation to hold assets like real estate, but for the most part – don’t do it!
Think about the tax election for your LLC. If you go with the basic default of Sole Proprietorship (single member) or Partnership (multi-members) you might not get what you want. Definitely get good tax advice before you make important elections with your tax return.
Mistake #2: Selecting the wrong NAICS code for your business.
The IRS will compare your selected NAICS code with other businesses with the same code. If your business is being compared with a different type, you’ll look off and that’s a bad thing when it comes to the IRS.
Mistake #3: Failing to elect to amortize your start-up costs.
You get a choice with start-up costs – amortize them over 15 years or taking an election to expense up to $10,000 in cost in the first year. But you have to make the election on your return!
Mistake #4: Not selecting the correct accounting methods.
There are three types of accounting methods: cash, accrual and hybrid. It’s amazing how many get this one wrong.
Mistake #5: Not taking the full amount of loss in the start-up year (or for that matter any growth year).
It’s easy to get lulled into a trap of “I don’t owe taxes, so I don’t need to look for deductions.” The problem is that when the business starts being profitable you’ve lost out on possible carry-forward losses. And if it’s not profitable and you have to shut it down, you’ve lost out on possible losses.
AUTOMATIC PRE-AUDIT PREPARATION
n
Everyone should do their upmost to prevent an audit on their taxes, but you should always be prepared for an audit. The best way to increase your chances of coming out of audit unscathed is to keep excellent records. The IRS will not take your word as proof of anything, so it pays to have as much documentation to back up your taxes as possible.
If you are not doing so already, set up a filing system and update it consistently. You can purchase online tracking systems and other software, but a simple spreadsheet is all you really need for your bookkeeping. This will help you get organized and give you a clear picture of where you stand financially. Here are a few tips to help you maintain a good bookkeeping system:
n
- Receipts – If you don’t have a receipt, don’t claim the deduction. If you can’t find a receipt, try to obtain a copy from the company who sold you the item. Credit card statements are dubious proof because many don’t itemize what you bought.
- Bills—Like credit card statements, canceled checks don’t prove anything except that you paid for something. If you pay a business-related bill by check, the important item to file is the invoice, along with the canceled check if possible.
- Mileage logbook—If you use your car for business, track all your business mileage. Keep a logbook in your car and use it at the beginning and end of every client visit and office-supply run. Record the date, starting and ending mileage, and the client name or other business purpose.
- Appointment book—You will need to keep your appointment book as a record of your business meetings, conferences you attended, and other business related tasks you did. The book will confirm your receipts and mileage and, in the event of a loss, helps you prove that your business is legitimate and real.
- Check stubs and invoices—Keep a copy of every invoice you send a client and the check stub that goes with that invoice.
- Account statements—If possible, use separate bank accounts for your business. File all account statements, both business and personal. Comingling will just create a headache for you as you try to make sense of countless personal and business transactions.
I address many of these issues in my Wealth Building Plan. Make sure you are getting the best tax advice. Let me evaluate your financial and tax situation, then develop a customized tax strategy just for you. Together, we will come up with a strategic plan designed to answer your questions as you build your own customized wealth-building plan. You can get more information at Wealth Building Plan
