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January 2007 — Vol. 84, No. 11

SMALL BUSINESS

How to audit-proof your business

Make a resolution to follow these tips

Related article:

By Chris John Amorosino

Freelance writer in Unionville

With the IRS auditing more S corporations and partnerships, it isn’t time to panic — it’s time to audit-proof your business.

Brian Newman, CPA, a 22-year accounting veteran who heads the tax department at Kostin, Ruffkess & Co., in Farmington, says preparation is the key to surviving a tax audit.

The partner in charge of Blum Shapiro’s Southport office, Mary Hoyt, CPA, agrees. Hoyt, who has dealt with tax issues for 30 years, points out that with tax returns, the burden of proof is on the taxpayer.

Newman and Hoyt both advise small-business owners to always keep accurate, updated records, because trying to prepare after receiving notice of an audit is difficult if not impossible.

Businesses need backup and support for all documentation, according to Newman. He has his clients keep third-party invoices, record all income, maintain all bank statements and reconcile bank statements frequently.

Both CPAs stress that neatness counts. Neatness and organization convey to the auditor a certain level of sophistication, which can make it more likely the business will be given the benefit of the doubt when and if questions arise.

Audit begins with a letter

The audit process typically starts with an IRS letter called an IDR, or information document request. The IDR lists items the auditor wants to see. Usually, says Newman, an IRS auditor will ask for items such as a cash receipts journal, a cash disbursement journal, bank statements, general ledger, balance sheet, income statement, and tax returns for the year being audited and often the year before and after. If something on the tax return triggered the audit, the IDR will mention that issue and ask for documentation.

To audit small businesses, the IRS often uses one of many industry-specific MSSPs, or “Market Segment Specialization Programs.” Auditors have an MSSP audit guide for everything from auto body repair shops to veterinary practices. You can see if the IRS has a guide for your type of business and download that guide from the IRS Web site . You can also call the Freedom of Information Act Reading Room at 202-622-5164.

Common mistakes

Among the common mistakes to avoid is giving the auditor too much information. Hoyt tells businesses to give the auditor only what he or she specifically requests. Providing unrequested documentation or mentioning issues outside the audit can open the business up to a wider audit and more-involved questioning.

Some businesses err by relying only on neat and complete record-keeping. That isn’t enough, says Newman. The business must also carefully reconcile those records and frequently check their accuracy, especially when they are electronic.

“You just can’t punch the numbers into a software program and assume they’re right,” Hoyt says. “You have to do the proper reconciliation with the outside documents, like bank statements, in order to get data that will hold up to an audit and be the proper data for your tax return.”

Another, very different type of mistake is not taking deductions for legitimate business expenses. Hoyt finds that many businesses deal with their fear of an audit by avoiding deductions. “To me, that is a totally wrong approach,” she says. “A business expense is either legitimate or not. If it’s legitimate, you take it.”

Filling in missing records

Don’t panic if records are missing or incomplete. Newman and Hoyt say there are often ways to retrieve missing information from sources outside the business. The business’s tax preparer can supply a missing tax return. The town can supply missing property tax bills. Missing invoices often can be supplied by the sender or receiver of that invoice.

The business owner’s calendar can also fill in some documentation gaps. Hoyt says calendars help make the case for travel expenses, appointments and seminars attended. An owner who claims $20,000 in conference and seminar expenses but has not kept receipts can review the calendar, call the conference sponsors and get the costs from them.

In truth, there is no guaranteed method for completely audit-proofing a business, according to Hoyt. Some audits are just the luck of the draw. If an audit notice arrives, Newman advises giving a known and trusted professional tax expert partial power of attorney. Doing so enables the tax professional to represent the business in all face-to-face dealings with the auditor while allowing the business owner to focus on the business rather than be consumed by the audit.

 

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