Even though the amount of resources the IRS is devoting to auditing tax returns seems to be waning, there still remains the overpowering risk of an audit to every tax return. A recent article published by Fortune Small Business provides individuals and business owners with several tips for avoiding tax audits.
Here are some items to keep in mind as you save documentation during the year for your 2001 tax returns. This is a list of items likely to draw unwanted attention to your tax return. Many of these problems can be avoided by simply being careful when you keep records and prepare your return.
- Independent Contractors. The IRS estimates that more than half of the nation's independent contractors are misclassified and really should be classified as employees. Companies reporting contract fees on their tax returns should be aware that the IRS is attempting to crack down in this area. In particular, contractors to whom you pay more than $10,000 per year should be scrutinized closely to see if they should be reclassified as employees.
- Repeat Offenders. Companies and individuals that have been audited in the past are likely candidates to be audited in the future.
- Rounding. Broad rounding of numbers calls attention to your return and makes it look like you don't keep accurate records. No records means no deduction. Start keeping better records to precisely document the information on your tax return, and report exact numbers instead of the rounded amounts.
- Cash Business. Businesses that deal primarily in cash are strong candidates for audits. The IRS is concerned that some of the cash goes into the owners' pockets without getting accounted for in the business records. The IRS has developed extensive guidelines for its auditors to help them catch the signs of attempts to hide cash. Keep controls in place to accurately document all cash transactions.
- Neatness. The IRS likes neat and tidy tax returns. Make sure your numbers are easy to read and that all appropriate supporting schedules are attached.
- Extravagant Deductions. You probably don't need to be reminded that large, out of the ordinary deductions call attention to your tax return. If the expense is legitimately a business expense, go ahead and deduct it - but be ready to provide receipts and a good explanation.
- Inflated Compensation Packages. The IRS is on the lookout for business owners who pay themselves extravagantly. Find out what the norm is for your type of business and be prepared to document and explain anything that is extraordinary.