Avoiding a Tax Audit

The words "tax audit" strike fear into the hearts of business owners as well as individual tax payers. A tax audit is not the end of the world; and chances are, if you have documented your finances well, you will emerge "unscathed." While you cannot be 100% certain you will not be audited by the IRS, there are several precautions that will reduce the probability of an audit.

Documentation

Save all your receipts and document all expenditures you will report on your tax return. Tax filing time is not a good time to rely on memory. Do not claim deductions you are not entitled to receive. If you are unsure if you qualify for a specific deduction or do not have the documentation to back it up, your tax preparer can help determine if you qualify. You should retain all records and receipts for your tax returns a minimum of three years. This will save you headaches down the road if you are audited for a previous year's tax return.

Avoid Careless Errors

Although it may seem obvious, make sure to sign your tax return before filing. Check and recheck your mathematical calculations. Math errors and incorrectly reporting a tax identification number or social security number can trigger an inquiry by the IRS.

Do Not Withhold Information

You need to report all income no matter how insignificant the amount. You should be aware that all tax documentation you receive such as W2's and 1099's are also received by the IRS. Just because you do not report it, does not mean they do not know. This includes even very small amounts of income such as interest from a small savings account. If there is a discrepancy between what you have reported and information the IRS has received, chances are you will be audited. Make sure your federal and state tax return reflect the same information. The IRS has information-sharing agreements with states agencies.

Keep Your Personal and Business Expenses Separate

One of the most common problems the IRS find with small businesses is claiming personal expenses as business expenses. You should have a separate bank account and credit cards for your business. Business-owned autos also come under close speculation. Business-owned autos should not be used for recreational purposes. Keeping clear documentation of personal and business expenses will help you answer any questions the IRS may raise.

Consider Incorporating Your Business

Small business owners receive more audits overall by the IRS than businesses who incorporate. A business who incorporates is also eligible to claim more deductions. Although there is an additional expense to incorporating, the IRS itself reports small business owners face audits more than 10 times as often as incorporated businesses.

Avoid Late Filing

Filing a late tax return automatically red flags you for a closer look by the IRS. Try to file all returns by the required filing date. If you must file an extension, try to pay at least a portion of the taxes due. Filing taxes by the required filing date shows you are compliant and not trying to hide anything.

Choose Your Tax Preparer Carefully

A qualified CPA can give you the added help you need in accurately preparing and filing your tax return. Check your tax preparer's qualifications. CPA's are most often members of professional organizations that require them to take continuing education courses and stay up-to-date with the latest tax laws and regulations. Professional accounting organizations have a code of ethics that all members are held to. A qualified tax accountant has expertise in knowing what triggers IRS audits and can help you minimize your risk. Remember, you are legally responsible for what is reported on your tax return even if it is prepared by someone else.

Be Prepared

If in spite of all your careful record keeping and accurate reporting, you are still audited by the IRS, do not panic. Often, there are just items on your tax return that require clarification or further explanation. The IRS also conducts random audits, so you may just have been fortunate enough to be one of those "randomly selected" returns. If you have carefully documented all expenses and income, the audit should go off without a hitch.

References:

Tax returns and record-keeping; IRS audits and income tax - MSN Money

Tax Filing: Ten Ways to Avoid an IRS Tax Audit - ABC News