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  • By Lauri Paxton
  • 19 Sep, 2013
Small businesses and self-employed persons are favorite targets of IRS audits. Here are five tips to keep your tax return from getting audited.
1. Be scrupulously honest.  
Report all income, even when you don’t get a 1099 or W-2. Deposit all cash, religiously, into the business account. Don’t take cash, bypass depositing it into an account, and use it to pay expenses. If the agent sees a lot of this, it’ll make the case easier for unreported income. Remember: The burden of proof is on the taxpayer. Ignorance and sloppiness are not an adequate defense. Regarding deductions, don’t try to reach. Always ask yourself: Is this a defensible position? Am I clearly entitled to the deduction? Here’s an expression one hears often: “Pigs get fat, hogs get slaughtered.” I’m told it was first uttered by a judge — in a tax case.
2. Speaking of deductions, beware of “constructive dividends.”
This is a favorite of the IRS. Small business owners often use the corporate account to pay for personal goods or services, such a car used for the personal errands of the owner, non-business meals, vacations, home improvements, and so on. IRS and the state tax agents know it, and look for it. If it’s personal, report it in your personal income tax return or reimburse the company and make sure to give it only the correct tax treatment as compensation, or dividend, in consultation with your bookkeeper. This is often one of the charges in a tax criminal case.
3. Use a reputable tax preparer.
The Tax Code  is very complicated. Furthermore, the law changes every year. The person preparing your return should have credentials (education and experience). Mistakes, including math errors, in one part of the tax return increase the odds that the whole return will be audited. Don’t pick someone because they promise to get you the biggest refund or the lowest tax bill. That’s a red flag signaling a fraudster. You don’t want to be questioned by the IRS when they investigate this tax preparer’s entire client list.
4. Keep good records.
Of course this is something you should have done throughout the year, but you can still heed this advice for the coming year. Keep your receipts, especially for expenses you deduct. You will be asked for them on audit. Remember: To deduct actual mileage you must keep a“contemporaneous” log, i.e. at the time of the trip, not a reconstruction weeks afterward. Likewise, you want to have invoices for an payments you make. (Otherwise, on audit, how do you prove the deduction you took for office supplies wasn’t just money you pocketed? Bring the paid bills from Staples.) Meticulously deposit all your income into an account and pay your bills out of that account or designated credit cards. If you’re self-employed, or have a side-line business in addition to your employment, DO NOT commingle income and expenses of your business with your personal. Keep and use separate accounts, ATM cards, and credit cards for your personal transactions and your business transactions. One of the biggest problems we face as tax practitioners working with small businesses is the lack of good record-keeping. Just keeping “books” makes such a difference for business planning and profits, as well as defending an IRS audit.
5. Keep regular books if you have a business.
It’s good business practice to keep books during the year. Many self employed individuals get into tax trouble because they didn’t pay estimated taxes during the year and so don’t have the cash (or available credit) to pay when they file the tax return for the year. Had they paid estimated taxes during the year, this would have been avoided. From a business point of view, they would also had a better idea of profitability had they taken into account tax “accrual” expenses building up during the year. So many contractors under-bid construction jobs because they don’t take taxes into account.
Being accurate during the course of the year can save heartache, time and money if the IRS should come knocking and want to audit your small businesses’ books.
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