10 Things I learned from my Client’s Recent IRS Audit
Last month I sat with my client through the grueling process of an IRS audit. It was not fun and I don’t wish it on anybody. Here are 10 things I learned and recommend you follow to a “T”:
Do NOT deposit any personal money into your business unless it’s absolutely necessary. If it is absolutely necessary that you fund your company, do it as a transfer if possible. These are easily spotted by the agent. 2nd choice? A check. If you do deposit a personal check, do your best to get a receipt showing the check image, if possible. Or photocopy the check so you can at least reference it back to your personal bank statement as proof that it was in fact a personal check. Whatever you do, do NOT deposit cash at the counter or ATM. It will be hard to prove where it came from. They’ll want to assume it’s income from a client.
Do NOT withdraw cash from your business unless you’re good at keeping all receipts (I don’t get tired of recommending Shoeboxed.com- it’s beyond me why people don’t jump at opening an account.) It makes file cabinets magically disappear and you have access to not only your receipts, but your business cards, and other documents online as well. All you have to do is write on the receipt and stuff it in the envelope. When the envelope is full enough, mail it! Or take a picture of the receipt with the app on your phone/tablet and it’s instantly online. Throw away the receipt and never worry about it again! PLUS- IT’S IRS APPROVED AS BACKUP OF YOUR WRITE-OFFs!!!). All cash will automatically be classified as a personal expense by the IRS and YOU will have to take the time to prove that it’s not. A $10K cashier’s check receipt saved my client from (1) not being able to write off the $10K as business expense and (2) not being taxed for $10K as personal income.
If you’re an employee of the corporation you MUST be on payroll. Think you’re not an employee? My client’s spouse was the only shareholder of the corporation for whatever reason. Don’t think you’re entitled to draws or can be considered the owner by the IRS just because your spouse owns the corporation. He was considered an employee and that meant he needed to be on payroll.You’ll get hit with payroll taxes, penalties, AND interest on the funds you took out as draws or any personal expense you ran through the company (whatever they reject becomes a personal expense). Interest accumulates daily. That can pile up!
Don’t include transactions in tax return that did not clear the bank that year. If you’re asked to prove an expense from your tax return and it doesn’t show up in your bank statement as of December 31st, it won’t be accepted as a write off for that year. By that time you most likely filed the next year’s tax return and well, you either included it again in the following year or you didn’t. Either way, you want to keep things clean by only claiming what “cashed” your bank that year if you file on a cash basis.
Keep a vehicle mileage log if you’re taking the Automobile deduction. So many people don’t want to do this. I just bought a mileage log at Office Depot for $3.29. There’s no excuse. Leave it where you can see it in your car with a pen. Write the mileage every time you turn on the car and every time you arrive somewhere. Seems annoying and tedious but you won’t think so when IRS comes asking for it. My client didn’t have it and all $7000 of car expenses were rejected by the IRS. If you take the mileage deduction instead of the expenses, this can be a huge hit on you.
Do not include lunches as Meals & Entertainment deduction. Do not include drive-thru purchases or any fast food restaurants. Unless you’re in the habit of taking prospects and clients to fast food places because it fits your industry, don’t include them. If you’re a lawyer servicing high-end clients the IRS knows you’re not taking them to McDonald’s and spending $6.00 on a business lunch (please tell me you’re not LOL). You MUST keep dates when you have these meetings over meals or events and who you met with. A log is required here or the name of the prospect/customer on the receipt you’re keeping in Shoeboxed (ha ha!)
Do not take the home office deduction if you have a commercial location and your industry requires you to tend to customers there. Do not take it if you can’t prove you used the entire square footage you listed as business. Do not include rooms of the house where it’s obvious you could’ve used them for personal use, even if occasionally.
Don’t make the mistake of thinking your QuickBooks or any other accounting file will replace the bank statements as proof. The first thing the IRS agent will ask for is your bank statements and possibly work off that only. They will only scan through your accounting reports for additional details. If your bank statement nor accounting reports provide enough details to prove that it’s a business expense, they will be excluded, and it’ll be up to you to prove that they’re in fact business expenses. That might not seem like a big deal but trust me, you’ll spend hours compiling everything that is business if you don’t already have it organized somewhere.
Reconcile. Reconcile. Reconcile. I can’t believe how many business owners think they don’t have to do this. Yes, you might have a super-duper data entry assistant who tracks everything. Yes, you might use banking downloads but even that has glitches and cannot be trusted 100%. The meaning of “reconciling” in accounting is simple: matching what’s in your register with what the bank lists in your bank statement. Reconcile your account monthly. You have no idea how many bank errors and missing money from merchant accounts I’ve found my clients by reconciling their books. I’ve found thousands of dollars they were cheated from!!!! If you don’t reconcile your bank statement a lot will be rejected from your tax return. Again, they ask for your bank statements first.
Last but not least, be pleasant and polite. The agent is a government employee not the IRS altogether. He/She should let you know during your 1st meeting that he is not the final authority and doesn’t have the final word. If you’re not satisfied with him or her, you may request someone else or you may speak to their supervisor. But, be pleasant and helpful to begin with. He/She will be more open to working with you if you maintain your poise and professionalism.
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