Strong offense is best
The IRS is more likely to scrutinize certain types of businesses, such as those that are primarily cash-based. You're probably not going to change your industry, so focus on things you can control, namely your tax returns. Minimize errors by keeping meticulous records and working with a reputable tax advisor.
Certain tax return items are likely to raise red flags with the IRS. These include:
•Significant inconsistencies with previous years' filings,
•Understated or overstated income,
•Errors related to employee compensation,
•Miscalculated or unusually high deductions compared with your income, and
•Expense and gross profit margin disparities compared with other businesses in your industry.
It's critical to have supporting material ready. The tax code generally requires businesses to maintain tax-related records for at least three years from the due date of the return — the normal statute of limitations for an IRS adjustment.
But mount a vigorous defense
If, despite your best efforts to file accurate returns, you receive an audit letter, don't panic. Contact your tax advisor immediately; then ask the IRS to postpone your audit to give you time to prepare.
Assemble the documentation you might need, including payroll records; contractor invoices; interest and dividend income statements; cash receipts and disbursement records; credit card statements; proof of payment for cash expenses; property and equipment purchase documents; and salesperson logs. Generally, the IRS provides a detailed list of what it wants to review. Provide the investigator only with the documentation required to make your case. If difficult tax issues or conflict or fraud allegations arise, let your tax advisor take over.
A small price
Even if you prove any errors were unintentional, it's likely that you'll have to pay something. Typically, this means the tax amount you underpaid, plus interest and a 5% penalty. But if you've prepared for this day, any financial damage probably will be minimal. •
Other articles in the April 2012 Edition of Business Matters: