With IRS Audits on the Rise, Knowing How to Avoid or Resolve a Tax Audit Could Save You Money and Protect the Future of Your Business
Tax audits are on the rise and small-business owners are the largest source of uncollected taxes, according to the Internal Revenue Service. In fiscal year 2007, audits of S Corporations were up 26% and audits of partnerships increased almost 25% from 2006. With the growing federal deficit, proposed government bail out plans, and a push to close the $345 billion tax gap, we will be seeing stepped up enforcement by tax collectors who are likely to focus their compliance efforts on small businesses.
Business owners tend to be the biggest group of tax evaders, particularly during economic downturns, and there are far too many business owners looking over their shoulders in fear of the IRS.
Several states have already started putting more money and personnel into cracking down on tax cheats - large and small - to cut into their growing budget deficits. They have sent letters out to small businesses warning them of the consequences of not collecting or remitting state taxes.
With small business audits on the rise, it is more important than ever to know what triggers an audit, how to avoid being audited and what to do if the IRS is after you.
For anyone planning to start and/or grow your business, it is crucial to know how to avoid tax trouble. I know this because I am a business owner myself. Plus, 25% to 30% of my tax relief clients are small businesses with tax problems. I always tell people who are struggling to overcome their tax burdens that knowledge is power and the key to gaining a new lease on your financial life.
What could trigger an audit?
The number ONE red flag in triggering a tax audit is claiming false business expenses. Monies from your expenses payments must be used for legitimate business-related activities. However, many people end up in tax trouble when they used these monies for personal purposes and falsely characterize them as legitimate business expenses. This can be seen as a failure to report additional income on your tax return.
Avoid payroll tax problems
Generally, owing payroll taxes is the "kiss of death" for many small business owners, whether they operate their entities as a sole proprietorships, corporations ("C" or "S" - doesn't matter) or LLCs. Many lose their businesses. When it comes to payroll tax debt, the IRS has unyielding power and authority to collect. They have the power to padlock your front doors, putting you out of business, without obtaining a court order. The penalties can add up to about 33% PLUS interest in just 16 days after you have filed the 941 (payroll Tax Return) past the due date and didn't pay! You can imagine what the debt adds up to if you ignore this for a prolonged period of time.
There are three major penalties that cause this: The failure to file penalty, the failure to deposit penalty and the failure to pay penalty. Additionally, if the IRS can prove that you were willful and intentionally (very low thresholds) didn't file and/or pay it may be considered a federal crime.
Generally, you must make a federal tax deposit (by tax filing service, phone, or in person at a bank) 3 days after the pay date of the pay roll checks.
Hire a good bookkeeper and accountant to avoid IRS tax problems
One easy way to avoid tax problems is to hire a good bookkeeper. You should have a capable bookkeeper that knows double entry accounting. There should always be a debit and a corresponding credit, and they have to go to the right place. So in other words, if you record a sale, you have to debit accounts receivable and credit sales. When you get the cash in, you debit the cash and credit the receivables.
Also, hiring an expert CPA or EA to prepare your return is a small annual investment that can pay off big! I would not recommend doing your own taxes unless you are a straight W-2 wage earner that takes the Standard Deductions (in other words, someone who doesnt itemize or have any unreimbursed employee business expenses). Tax preparation tools like TurboTax and TaxCut are great, but people with anything more than a straight W-2 (including anyone with even the smallest business Schedule C) should be aware of the limitations of these software programs.
So dont be penny wise and pound foolish. You are going to have to invest in a good bookkeeper and CPA, but I cannot emphasize enough the importance making this initial investment now to help you avoid tax problems later.
File your tax return on time, even if you dont have the money to pay your tax bill.
If you cant afford to pay your taxes, you can still file your return on time and save 25% on the failure to file penalty right off the bat. What many people dont understand is that filing an extension just puts off the inevitable, because its not an extension of time to pay, its just an extension of time to file. So what we tell our clients is that no matter how much is owed, if they enclose a check for $5 or $10 with the return and file it on time, it will reduce their filing penalties. Additionally, it creates a computerized record of account at IRS showing that you sent in a payment with your income tax return (reflecting good faith and credibility on your part).
It is a misdemeanor in this country not to file a legally required return when it is due? Thats the whole reason why Wesley Snipes is going to jail! You must file your taxes on time to avoid criminal investigation and subsequent charges.
Penalty proof you small business when filing for IRS tax extensions
If you need to file for an extension, keep in mind that an extension of time to file is NOT an extension of time to pay. However, filing an extension on time can help you save money and avoid hefty penalties, which generally accrue at 5% of the total tax liability up to a maximum (5 months) of 25%. Add to that interest and the failure to pay penalty and your total liability can easily double (increase by 100%) if you have failed to file for a few years and owe tax for each year. If you dont owe any tax and are late in filing, the failure to file penalty does not apply.
When filing for an extension, it is important to avoid underpaying your taxes. If you are forced to file an extension (due to not having all your information organized) you must send a check with the extension (less what you withheld or paid in through estimated quarterly taxes in 2008) equal to 100% of your total tax liability for 2007 to be (underpayment of tax penalty) penalty proof.
You may also penalty proof yourself by paying in 90% of what you think you are going to owe for 2008.
Even if you havent filed your federal income tax return for this year or previous years, it is crucial that you file your tax return as soon as possible. If you are not sure whether you are required to file a return or how to deal with payroll tax problems, consult an experienced tax resolution specialist for help. If you cannot pay all of the tax due on your return, you may be able to qualify for an IRS payment plan.
What do I do if I get audited?
The best thing to do is get expert representation! Fighting the IRS on your own is a lose/lose proposition. You WILL get creamed. Its like to going to court without a lawyer. If you are struggling to overcome your tax burdens, know that theres a solution to every problem. But you have to be willing to do something about it you cant just stick your head in the sand and ignore the audit letters.
Theres hope for taxpayers who have incurred the wrath of the IRS. But you will need a seasoned tax professional who is a Certified Tax Resolution Specialist to help you put together a tax relief action plan. An ethical and experienced tax resolution company can help you reduce your IRS debt by qualify for an offer in compromise settlement where the IRS will accept a much smaller lump sum for the total dept thats owed if you can prove that you do not have the future ability to pay the IRS off.
Other tax resolution strategies include payment ("stepped") plans, offers in compromise, computational abatement of penalties, abatement of penalties due to reasonable cause, and analyzing the statute of limitation to assess. For more advice and information on small business taxes and how to get professional help if youre in trouble with the IRS, visit the Tax Resolution Services web site for a free consultation.
About the Author: Michael Rozbruch is one of the nation's leading tax experts. A Certified Tax Resolution Specialist (CTRS), licensed CPA in the state of Maryland and the founder of Tax Resolution Services, he helps individuals and small businesses solve their IRS problems and is dedicated to educating the public on tax planning and other strategies for managing their personal and business finances.