Getting audited stinks. We’re raised to fear the mere mention of having our financial holdings questioned because it can lead to steep financial penalty, headache, and even jail time. But if we keep abreast of current changes in tax laws and are diligent with record keeping, then everything should be copacetic. Just in case, here’s a checklist of things to note when getting all that paperwork together for your company’s tax specialist.
Get to know your accountant, really. And he or she should know you well too. The person doing your taxes should not be a stranger. They should know who you are and how you live (and spend your life). Bonus: one, if not both of you can write off the expense of lunch or dinner as work-related.
“CPAs are lawsuit proof,” says Micheal Lovecraft, a former “Big Four” auditor in Texas. “So you have to have a relationship with them. You must be prepared. If you walk in with your revenue and expenses and you haven’t labeled anything, then this way they can peel away the various layers at a lesser expense.”
Choose an industry specific accountant. By industry specific that means your industry. That’s someone who knows and has experience in your field. You want a tax specialist who is familiar with as many situations as possible to handle your taxes. If you run a small software company, you certainly don't want an accountant who exclusively has experience doing taxes for teachers. “It’s a different language for every industry,” says Rachel Solomon, CPA, LLC, a tax consultant at Watkins Meegan Drury & Co LLC, in Maryland. “There are some accountants that are specific to high tech industries so you want an accountant who specialized in that type of tax law. You want someone to know your industry’s nuances.” In addition, your accountant should not only know your industry, but also your company’s goals. “The process begins with what happened last year, says Solomon. “Look at last year to see how we can reduce the liability.”
Be honest. There’s tax planning (reducing one's tax liability) and then there’s tax avoidance. Tax avoidance is illegal! “As a small business owner, it is absolutely critical to ignore the advice of others unless it is in fact a tax professional,” says Lovecraft. Don’t listen to: My friend, who has been in this business for 30 years, says, as a retailer, I am exempt from self-employment tax. “There may well be a retail sales tax exemption in your state, but there is no such thing as a Federal SE exemption for retailers,” says Lovecraft. Ask this question out loud: Do you really think the Feds aren't going to want a chunk of your net income?
Consider regional tax professionals vs. the fancy guys from the Top Four accounting firms. Do you really need the bells and whistles that your small business won’t even use but will certainly pay for when employing KPMG, Deloitte and Touche, PriceWaterhouseCoopers and Ernst and Young? “Regional firms are good because they are the ones who tend to really specialize in your industry, says Solomon who works for a regional firm.
Really understand what a write off is. For the hands-off clueless types, nothing is free and not everything can be 100% deducted. Take food, alcohol and entertainment for example – only 50% deductible for those expenses. “The thing about the law and the IRS is that one word changes everything,” says Solomon. The law changes year-to-year so keep up with amendments. The slightest change in words can make or break an audit. “People don’t know the rules well enough,” says Solomon. “It’s more ignorance than anyone purposefully trying to get around the law, but that’s when they audit you.”
Bookmark the IRS webpage. Get over how you feel about the much-loathed acronym. Most digestible are the articles listed in their newsroom citing tax law changes, etc. The double speak and jargon can be daunting. “It can be intimidating and it isn’t a beautiful site,” says Solomon. “But the articles in the Newsroom are excellent and the results you get for searching key words like ‘small business’ are the best.”
Familiarize with the grey areas. There is a lot of grey area regarding tax law, and it’s impossible to cover every scenario. Take, for example, first time homebuyer credit, says Solomon. “You have to be over 18, purchase the home as a principle residence, and you have limits to adjusted gross income. That sounds straightforward and clear, but then what does principle residence mean to you and what does it mean to the IRS? If I buy a house and I don’t live in it, but I rent it out, isn’t that the principle residence if it’s the only home I own? Well, the IRS sees a principle residence as the house you intend to live in.”
Know the most popular audit triggers. Not to sound pedantic but what gets the attention of the IRS most is the obvious – not filing at all. Moving from a net loss one tax year to a significant net income in the next tax year (or having W-2 reportable wages in one year then none at all) is another red flag. After that? “Extensions and amended returns get attention,” says Lovecraft. “Also, entertainment expenses are not tax deductible -- and anything reported to the IRS directly [along with] withholding, interest is a trigger.”
Take advantage of the IRS’s consecutive three-year loss. A small business should take advantage of this situation. Well, “provided the credit crunch has not made the terms and covenants of financing a Catch-22 of gross margin versus big tax bills,” says Lovecraft. “Net Operating Losses can be generated in those three years, and there are carry-backs and carry-forwards of NOLs that can be further exploited in those cases.”