Cleaners: How to survive an IRS audit

by Neal Seymour

Having your own carpet cleaning or contract cleaning business is great.

It is growing and you are prospering. Business is good. Life is good.

Then the unbelievable happens, which turns your world upside down and pushes you into pure panic.

This panic mode is instantly

brought on by receipt of an Internal Revenue Service (IRS) audit letter.

Most of us don’t fear something exploding or catching on fire as much as we fear an IRS audit.

Of course, the best way to survive a tax audit and even to come out of it successfully is not to panic, but to prepare. That’s hindsight, of course…

Why me?

The IRS especially scrutinizes the self-employed because the agency claims that most tax cheating is done in small businesses, such as ours.

There is some logic to this because, in a self-employed business, there are many more opportunities to blur the difference between business expenses and personal expenses.

Also, many self-employed people put the idea of proper record-keeping and the cost of hiring accounting and tax professionals at the bottom of their priority list.

It is not uncommon for many of us to concentrate more on the technical side of cleaning and restoration than on the business end of properly accounting for our true business expenses and

deductions.

It is a statistical fact: Self-employed individuals are much more likely to get audited than regular employees.

The really, really bad news

You can be investigated by the IRS through a tax audit (which is very serious) or through a criminal investigation (which is even more serious).

The criminal investigation arm of the IRS can come bearing badges and guns, as it is an investigation of fraud against the United States government.

In any such investigation, the IRS can (and probably will) obtain your bank records and other financial records, both business and personal.

Virtually all small businesses involve close ownership with profits or losses going ultimately to the business owner. This is why the IRS looks closely at your personal accounts.

Any instance of depositing unreported income in a bank account will probably show-up in an IRS audit.

Small businesses which prepare their own tax returns (as opposed to going through a tax professional such as a CPA) are more likely to be audited.

It is wise advice to have your business accounting performed and checked by a legitimate accounting professional and to have all small business tax returns prepared by a tax professional.

Tax is a complex issue

As an example, do you know the difference between "current" expenses and "capitalized" expenses?

When it comes to current expenses, do you know if you would put carpet prespray chemicals as expenditure under "Cost of Goods Sold" or "Expenses"?

Do you know the rules for taking a Section 179 deduction on expensing capital expenditures?

You get the idea.

 

Take it seriously

Even though IRS audits are fairly routine events, they should be taken with the utmost of seriousness.

In the event you receive an audit letter, you should immediately spring into action to ready yourself for the audit.

If you try to put it off, any penalties and interest will just become that much bigger.

The IRS usually sets the time and place for the audit.

You should amend your schedule to comply with their date.

Think of not showing up for an audit the same as not showing up for trial in a courtroom. It is that serious.

What the tax man looks for

A tax auditor is looking for certain things when they audit you and your business.

The IRS training manuals note that the auditors are examining you and not just your business tax return.

Your lifestyle may be checked against your reported income to see if there is a discrepancy which shows skimming, diversion of funds or deception.

That mansion with the truckmount van parked out front may send up the wrong "economic reality" flag.

Travel and entertainment deductions in a business are usually suspect as some people try to deduct personal entertainment and meal "business" expenses.

You must be able to clearly explain the business relationship in a credible fashion.

Taking your friends out to the ballpark or taking the family on a vacation to that industry

conference may not quite pass the litmus test of an audit.

Writing off 50 percent of your legitimate business entertainment expenses requires detailed explanation of the reason for the expense, as well as a receipt.

You are a service business, whether you are in carpet and upholstery cleaning or restoration.

Your business revolves around your scheduling calendar.

Your calendars will undoubtedly be scrutinized to make sure there are no glaring gaps between possible work, vehicle or equipment usage and the income

reported.

As an example: If you are claiming 100 percent business vehicle usage but your calendars do not confirm the times and locations of service stops, you may be open to an analysis of possible personal use of the vehicle.

Entries in a business diary or calendar help to justify an expense to an auditor as long as it appears to be reasonable.

Business credit cards are also highly scrutinized as they have a high potential for misuse (such as use for a personal vacation or personal expenses).

Keep these only for legitimate business expenditures (places where company checks won’t do).

Too many times a small business owner says that they will "reimburse the business later" for that personal expense put on the business card.

This just opens you up for closer inspection.

Documentation is important

Deductible payments to family members or to another business which your relatives own (related parties) will definitely raise a flag, as taxable profits can be taken out of your business for direct or indirect personal benefit.

This may be seen as diversion of funds. Think hard about paying "consulting fees" to that brother-in-law.

Lack of documentation or large gaps in documentation will cause you more problems than anything else.

Accurate and exhaustive record-keeping will go the longest way in protecting your business in the event of an IRS audit.

Use of business vehicles

The use of business vehicles for personal use will probably be audited, as this is one of the most common deduction problems small business owners face.

Keep detailed records of vehicle use for your business. Too many small business owners think that the IRS won’t look at vehicle usage.

As an example, if you put 26,000 miles on a truckmount van per year but only have 140 hours on the hour meter of the truckmount system, it may raise a few concerns that the "company vehicle" may have been used for personal use.

Types of business vehicles may be challenged.

Some people mistakenly think that putting lettering or a vinyl sign on your decked-out SUV automatically makes it a "company vehicle," which can be written off your taxes as a pure business expense.

Obvious business vehicles such as your truckmount van or restoration cube truck which have little use other than that in your exact business are easy to defend.

Quasi-business vehicles will be harder to defend.

Independent contractors

The IRS targets audits of businesses which routinely hire "independent contractors" due to the amount of tax irregularities

involved in typical tax reporting.

You may be overstepping the line of implied employment and not properly paying payroll and benefit taxes.

You may want to rethink paying your nephews or nieces as "contractors."

You think it is much easier to just "write-off" the expense of a "contractor."

Well, the IRS may have other ideas.

Preparing for an IRS audit

Your best defense is based on three things: Record keeping,

record keeping and record keeping!

Get in the habit of keeping good tax records year round.

These are all your records of income and expense.

Your credit card and bank statements may not tell the whole picture.

Don’t just wait until April 15 to pull your records together, as you’ll be scrambling to try to "reconstruct" your business year.

Primary records are your bills and receipts; these are the mainstay of your expenses.

Secondary records include mileage logs, spreadsheets or other summary information you’ve kept.

It is this secondary record information which can be the deciding factor in an audit opinion.

Make sure you collect all records that substantiate your tax return, and make sure they are organized in a logical manner to make it easy for the auditor to go through them.

Refresh your memory by going through your receipts, checks and other items which you are pulling together for the audit.

 

Neatness is very important, as auditors quite often reward good record keepers by giving them the benefit of doubt.

If you just dump out a shoebox full of receipts, you may be giving the IRS an opportunity to dig through until they find more irregularities.

Stuff you need

Be prepared to bring bank statements, cancelled checks and receipts for both business and personal expenses.

Remember this audit is an invasion of your privacy, but one

which you have agreed to by having tax laws passed.

If you are not claiming bizarre business deductions for actual personal use, your audit may turn out to be routine.

Electronic statements don’t always show the business nature of your expenses, so you need secondary records to help explain the expenses.

If you don’t produce sufficient business records, the auditor can legally estimate your income and expenses and impose a separate penalty for your failure to keep business records.

Be prepared to bring appointment

books and vehicle logs, as you may have to verify your tracking of activities and expenses in a service business.

Remember, the detailed documentation of the use of your assets will go a long way in satisfying curiosity about the legality of your deduction.

It is a good idea to keep all your past tax returns and the backup information for the current year, plus three past years.

You may want to familiarize yourself with these documents before the audit.

Professional help

If you have a tax professional representing you in an IRS audit, he or she may recommend that you not attend the actual audit hearing.

This is so you do not unintentionally reveal information that is not required, and which could potentially cause more problems.

Remember: The IRS wants to exactly pinpoint issues as set forth in their audit letter.

A tax professional (working under your IRS power of attorney) knows how to handle the questions much better than you do.

Survival of the fittest

An IRS audit is a stressful, traumatic event.

Audits are a way of life for small businesses.

Don’t fear or panic. Your best defense and the key to surviving is to prepare properly for the audit.

The IRS will audit the sections of your return they have questioned in their audit letter.

This gives you time to pull your defense together on these particular points.

Get in the habit of keeping good tax records year round. Don’t just wait until April 15 to pull records together.

Primary records are bills and receipts.

Secondary records include mileage logs, spreadsheets or other summary information you’ve kept.

Collect all records that substantiate your tax return and make sure they are organized in a logical manner to make it easy for the auditor to go through them.

Be prepared to bring bank statements, cancelled checks and

receipts for both business and personal expenses.

Be prepared to bring appointment books and vehicle logs, as you may have to verify your tracking of activities and expenses in a service business.

Behave professionally. Dress appropriately, be on time for the audit, come well-organized and, most importantly, take the audit seriously.

The auditor is not your friend. The job of the auditor is to verify an implicit assumption that you may have done something wrong.

You are there to prove your

innocence as you are already presumed guilty.

Answer questions to fully satisfy, but don’t volunteer extra information not being sought.

This may create probes of other parts of your business which were not anticipated in the original audit request.

If you are not represented by a CPA, enrolled agent or tax attorney, remember that the taxpayer bill of rights allows you time to consult with one. But there is good news! Not all audits result in a taxpayer owing extra taxes or paying penalties.

Keep this in the forefront of your mind as you enter the audit.

Be confident that you will come across positive and helpful in the nightmare of the tax investigation. http://www.advantagecleaningteam.com/ or http://www.janiservu.com/