March 18, 2013

State of Alabama
Press Release: Alabama Department of Commerce

Small Business Advice: How to Alleviate Audit Anxiety

March 18, 2013

By John Nealon

Nealon offers a few tips to help you prepare for a second look by the IRS. (Ricky Carioti - WASHINGTON POST)

For some, common nightmares might include falling or drowning.

But for many small business owners, especially this time of year, a common nightmare might look something like this: You are sitting at your desk preparing for a long week of work, when suddenly, there’s a knock on the door. The door opens, an unfamiliar face walks in, and the next words you hear are, “Hi, I’m from the IRS.”

While it may be nothing more than a bad dream, small business owners should seriously consider whether they are prepared for an audit in case the day ever arrives. Recently, employers have had even more reason to be wary, as the IRS has continually increased the percentage of small firms being audited over the past five years.

Most employers who are audited haven’t done anything truly wrong; more often than not, they have made innocent filing mistakes. Still, there’s an understandable tendency for anyone going through the process to feel nervous that they’ll have to pay major penalties.

Here are a few practical steps to help small business owners feel more secure and better prepared if the IRS does come knocking on the door during waking hours.

1. Map out mileage

It may make sense for a small business owner to lease or buy a car through their company to use primarily for work purposes. Remember any personal use of this vehicle, including commuting, is considered a fringe benefit by the IRS and is therefore subject to tax, so it’s important to keep clear records and have a consistent method for calculating personal use of a company car.

While using the car to travel on vacation would clearly be characterized as personal use, there are other situations that may not be so cut and dry. Keeping track of mileage and documenting every trip will help support your claims should the IRS want to take a closer look.

2. Be frugal with gift giving

Especially when holiday season rolls around, you may want to send gifts to associates and clients – and that’s okay. Just keep in mind that you’re not Santa Claus and you have to stick to a budget.

Gifts are only deductible up to 25 dollars per person, which can be a tough number to stay under. A trap is sending a gift basket intended for an entire office, but addressing it to an individual.

If the basket costs more than 25 dollars and you aren’t clear about the number of recipients, it could draw some unwanted attention from the IRS. Make sure you keep clear records for what you bought and for whom it was intended.

3. Don’t mix business and pleasure

Meals and entertainment are deductible items – sometimes. Depending on the circumstances, they may only be deductible up to 50 percent of the cost. The costs must also be kept within reason.

Extravagant spending on weekly “business” outings will raise eyebrows, so keep receipts for meals and entertainment and make sure you keep records of the exact purpose of all expenses.

4. Be careful when lending a hand

Sometimes, business owners loan personal funds to their company to help cover a shortfall or to invest in new resources. Unfortunately, this process isn’t as simple as writing your company a check.

You must charge interest on the loan. Failing to do so might lead to an IRS audit in which they will set an interest rate and make you pay taxes on the interest you personally should have received from the loan.

You don’t have to set an exorbitant interest rate – just don’t make the mistake of setting no interest rate. The IRS even provides minimum rates for related party loans.

5. Mind your 1099s

There’s a number of issues that can arise with 1099 forms. Some small businesses misclassify workers as independent contractors when they are actually employees. Workers classified as employees require the business to pay more taxes, so the IRS watches this closely.

Additionally, businesses must file 1099 forms for any independent contractor or non-incorporated business that has been paid more than 600 dollars in the tax year. While this has always been a requirement, the IRS has now mandated that employers verify that they issued and filed all required 1099s. These additional requirements expose business owners to more risk if they fail to comply.

John Nealon is the small business practice leader at ParenteBeard, an accounting firm in Philadelphia.

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