Saturday, August 30, 2008

Safe Tax Tactics: Avoid an IRS Audit

Following a few simple rules can reduce your risk of an audit by the IRS, and protect yourself in the event that you are audited.

As a self-employed person, you are three times more likely than an employee who receives a W-2 form to be audited by the Internal Revenue Service, according to 2005 data from the IRS.

Combine that with the fact that the number of audits of small corporations has been on the rise in the last few years, and you have the potential for a real hassle.

But don’t despair; there are several things you can do to reduce your chances of being audited and to protect yourself in the event that you are.

File on time. Make sure you file both your income tax return and quarterly estimates before the deadlines. Nothing throws up a red flag and says “audit me” more than consistently filing your returns and quarterlies late. If you can’t file on time, be sure to file an extension. Remember, though, that extensions don’t eliminate interest charges.

Keep good records. One particularly vexing issue for salespeople who use their cars for business is substantiating business mileage with a properly documented mileage log. Few mileage logs are up to IRS standards. The IRS will accept either paper or computer-generated logs, but the IRS tends to view computer logs as less credible.

Double-check meal and entertainment deductions. Meal and entertainment costs are deductible up to 50 percent if they are ordinary (commonly done) and necessary to your business and are either directly related to the active conduct of your business or directly preceding or following a substantial business discussion on a subject associated with your business. Ordinary and necessary costs are those considered helpful and common practice in your industry. You can entertain business associates in nonbusiness settings such as restaurants, theaters, sporting events, and nightclubs, provided the entertainment directly precedes or follows a business discussion. Business associates would include clients, prospective clients, suppliers, employees, partners, or advisers. You should document where the meeting was held, with whom, and the purpose of the meeting. Keep this information with the receipt.

Classify your workers properly. A top audit trigger is a business—such as a real estate brokerage—that treat workers as independent contractors. Questions are more likely to arise about the employment status of office personnel or assistants working for salespeople. If the IRS rules that these workers are employees, you could owe employment taxes, penalties, and interest. While federal tax law provides a safe harbor that classifies real estate salespeople as independent contractors, unlicensed assistants do not have such protection. One important factor in determining independent contractor status is behavioral control, or to what degree workers control how, where, and when they work. If a worker receives extensive instructions on how work is to be done, it suggests employee status. If a worker receives benefits such as paid leave, health insurance, or a retirement package, this might also indicate employee status. For further details on the distinctions between independent contractors and employees, go to and read Publication 1779.

Review IRS audit guides. Audit technique guides were developed by the IRS to assist its agents in performing examinations. These guides contain examination techniques, industry issues, business practices, industry terminology, and other information to assist examiners in performing audits for particular industries. These guides are available to the public at the IRS Web site so you can obtain them and learn in advance what issues the IRS will examine during an audit.

Get good advice. If you’re not aware of new twists in the country’s constantly changing tax laws, you might cost yourself money. If you have a question regarding possible deductions or how to report income, ask a tax professional or call the IRS directly. The money that you spend for good advice up front can pay you back many times over into the future.

Follow these easy steps, and you’ll reduce your chances of an IRS audit. At the very least, you’ll have appropriate backup for your deductions to satisfy even the toughest auditor.

Source:National Association of REALTORS® (8/30/08)

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