The jokes about being audited by the IRS are endless. But if it happens to you, it’s no joke. Do you want to protect yourself?
First, understand why businesses may be audited. Below are some clues as to why you may be selected:
- DIF Score: When your tax return is filed, the IRS gives it a DIF (discriminant index function) score. The higher the score, the more likely it is the return will be chosen for an audit. The problem is that the IRS doesn’t disclose the DIF mathematical formula.
- Referrals: Every business loves warm referrals. Except this kind. When a related party is chosen for an audit, they aren’t the only ones who’ll come under the microscope. If you’ve been paid by a business that’s being audited, your business tax return could then come up for audit.
- Document Matching: The IRS matches the payer’s reported income to the 1099 or W-2 issued to the payee to make sure the payee has reported the income.
If you do find yourself under the microscope, know what the IRS will be looking at:
- Your Lifestyle. Auditors pay attention to much more than your forms. They size you up for how you dress, expensive jewelry you might be wearing, the car you drive and furnishings in your home or office. Appearances that don’t match up to your reported income could cause trouble.
- Cash Status. If your business is primarily conducted with cash, the auditor might suspect that the cash goes directly into your pocket and is not reported.
- Car Use. Are you a one-car family that reports 100 percent business use for the car? The IRS is pretty smart, and can figure out that if you have only one car, you will be making the occasional trip to the grocery store, among other places.
- Business vs. Hobby. Is your business truly a business, or is it a glorified hobby? Show the auditor that you are actively advertising for business, and/or that you’ve had success in prior years and this year you’re experiencing a slump.
If you’ve never been audited, consider yourself lucky, but don’t assume that it could never happen. Be proactive in your business rather than reactive. And if you are facing an audit, “Keep Calm and Call Your Tax Professionals.” They can take the emotion out of it, and, just as important, they know the tax laws. They also know ways to possibly keep you safe.
For instance, they might be able to unearth deductions that you could have missed. If that’s the case, it could possibly offset any discrepancies in your return that the IRS finds. Whether you will soon undergo an audit or want to be prepared for one, give us a call.