How to Avoid a Tax Audit

irs_audit_swanksalotflickr

Michael Rozbruch is a leading expert on resolving individual and small business problems with the IRS. He says tax audits are on the rise and worse – as a small-business owner, you are among the largest source of uncollected taxes. That makes you a target. According to Rozbruch, the growing federal deficit, proposed government bailout plans, and a push to close the $345 billion tax gap are all leading to stepped up enforcement by tax collectors. In this interview, Mr. Rozbruch helps us all avoid the sting of the IRS agent’s vist.

BP:  Thanks for providing your insights, Mr. Rozbruch. Why does the IRS seem to pick on small businesses?

MR:  Business owners tend to be the biggest group of tax evaders, particularly during economic downturns. With small business audits on the rise, it is more important than ever to know what triggers an audit, how to avoid being audited and what to do if the IRS is after you.

BP:  And is it just the IRS we need to be concerned about?

MR:  No. Several states have already started putting more money and personnel into cracking down on tax cheats – large and small – to cut into their growing budget deficits. They have sent letters out to small businesses warning them of the consequences of not collecting or remitting state taxes.

BP:  How important are tax issues to a new business?

MR:  For anyone planning to start and/or grow your business, it is crucial to know how to avoid tax trouble. I know this because I am a business owner myself. Plus, 25% to 30% of my tax relief clients are small businesses with tax problems. I always tell people who are struggling to overcome their tax burdens that knowledge is power and the key to gaining a new lease on your financial life.

BP:  What could trigger an audit?

MR:  The number ONE red flag in triggering a tax audit is claiming false business expenses. Monies from your expenses’ payments must be used for legitimate business-related activities. However, many people end up in tax trouble when they used these monies for personal purposes and falsely characterize them as legitimate business expenses. This can be seen as a failure to report additional income on your tax return.

BP:  What’s one of the biggest mistakes you see small business owners make?

MR:  Generally, owing payroll taxes is the “kiss of death” for many small business owners, whether they operate their entities as a sole proprietorships, corporations (“C” or “S” – doesn’t matter) or LLCs. Many lose their businesses. When it comes to payroll tax debt, the IRS has unyielding power and authority to collect. They have the power to padlock your front doors, putting you out of business, without obtaining a court order. The penalties can add up to about 33% PLUS interest in just 16 days after you have filed the 941 (payroll Tax Return) past the due date and didn’t pay! You can imagine what the debt adds up to if you ignore this for a prolonged period of time.

BP:  So what can a small business do to avoid getting audited by the IRS?

MR:  There are several ways to stay safe.

  • Hire a good bookkeeper. You should have a capable bookkeeper that knows double entry accounting. There should always be a debit and a corresponding credit, and they have to go to the right place. So in other words, if you record a sale, you have to debit accounts receivable and credit sales. When you get the cash in, you debit the cash and credit the receivables.
  • Hire an expert CPA or EA to prepare your tax return. It’s a small annual investment that can pay off big! I wouldn’t recommend doing your own taxes unless you are a straight W-2 wage earner that takes the Standard Deductions (in other words, someone who doesn’t itemize or have any unreimbursed employee business expenses). Tax preparation tools like TurboTax and TaxCut are great, but people with anything more than a straight W-2 (including anyone with even the smallest business “Schedule C”) should be aware of the limitations of these software programs.
  • File your tax return on time. Even if you don’t have the money to pay your tax bill, you can still file your return on time and save 25% on the failure to file penalty right off the bat. What many people don’t understand is that filing an extension just puts off the inevitable, because it’s not an extension of time to pay, it’s just an extension of time to file. So what we tell our clients is that no matter how much is owed, if they enclose a check for $5 or $10 with the return and file it on time, it will reduce their filing penalties. Additionally, it creates a computerized record of account at IRS showing that you sent in a payment with your income tax return (reflecting good faith and credibility on your part).

BP:  What if we do everything right and get audited anyway?

MR:  The best thing to do is get expert representation! Fighting the IRS on your own is a “lose/lose” proposition. You WILL get “creamed”. It’s like to going to court without a lawyer. If you are struggling to overcome your tax burdens, know that there’s a solution to every problem. But you have to be willing to do something about it — you can’t just stick your head in the sand and ignore the audit letters. Hire a Certified Tax Resolution Specialist to help you put together a tax relief action plan. An ethical and experienced tax resolution company can help you reduce your IRS debt by qualify for an offer in compromise settlement – where the IRS will accept a much smaller lump sum for the total dept that’s owed if you can prove that you do not have the future ability to pay the IRS off.

You heard the man, tell the truth, keep good records, and file on time!

Image Credit: swanksalot, Flickr

  • Thanks for posting this interview – it was very informative. I wanted to point out that you can also eliminate the 25% late filing penalty by filing for a tax extension. The point made is accurate, that an IRS tax extension provides more time to file, but not to pay. However, an IRS approved tax extension will give you 6 more months to file, without having to pay the late filing penalty. This may be a good alternative to rushing your tax return, and potentially submitting with errors. You can e-file for a tax extension in just a few minutes with online solutions like FileLater.com

  • leza farmer

    Great advice for small biz! IRS audits are scary. I like the tip about sending in a check with a $5 payment when you file to avoid penalty!

  • This is good information, but I wish there was more. Small business owners also have some of the greatest opportunities to use the tax code to their advantage, but some people create strategies that push too far into the gray area. It would be nice to hear about which of those strategies triggers and audit and which should be avoided.

  • Do you mind have a look at TradeMax? NoloSoft TradeMax is a tax software designed for active investors or traders to manage their trade data maximize their gain/loss strategy, prepare their Schedule D. http://www.nolosoft.com.

  • Stephen

    Should take a look at http://www.teaspiller.com, too. Good place to find tax experts who can help with audit prevention (and representation if it does happen).