Jacksonville Tax Preparation

Audit Flags for a Small Business

The IRS randomly audits businesses, still you want to avoid drawing attention to your business. Below are red flags that may draw an audit.

 Travel and entertainment expenses: Strict record-keeping rules for travel and entertainment expenses have evolved over the years. Generally, you must keep adequate records concerning the amount, time and place, and business purpose for travel and entertainment expenses. For entertainment expenses, you must also establish the business relationship of the person(s) being entertained. Document expenditures, such as receipts or credit card statements, is generally required for expenses of $75 or more.

Employment taxes: A small business may use independent contractors for services instead of hiring more regular employees. One key advantage is that the business is not liable for employment taxes on amounts paid to independent contractors. This is a traditional target of IRS investigators. Be prepared to prove that outside workers are not really employees.

If you can control what the worker does and how and when the work is done, he or she is generally considered an employee.

 Sole proprietors: Traditionally, sole proprietors have not been prime audit targets. Not anymore. In fact, the IRS now believes that this group accounts for more than twice the amount of unreported taxes as the largest corporations. Accordingly, the IRS has been focusing more on sole proprietors. The trend is expected to continue over the next few years.

Fringe benefits: The IRS often becomes suspicious when noncash benefits are granted to highly paid employees. For instance, it may examine compensation packages with benefits such as deferred compensation plans, employee stock options and split-dollar insurance arrangements. The IRS has launched a special examination program aimed at executive fringe benefits. It has also devoted several audit technique guides to fringe benefits (see above).

Owner compensation: If you are the owner of a business enterprise, you might think that you can pay yourself whatever amount you’d like. But that’s not true. The IRS will object if it considers your salary to be "unreasonable" under the circumstances. For instance, it may deem a C corporation owner’s compensation too high or an S corporation owner’s salary too low. Be aware that these cases are often contested in the courts.

There are no absolute guarantees, but your business advisers can help steer you in the right direction.