Why me? It’s the first question asked when the Internal Revenue Service selects an individual or businessperson for an IRS audit. Visions of past misdeeds or oversights ^__ the undocumented dinner, the cash not reported ^__ immediately trigger a flood of guilt.

If you are a sole proprietor and file a Schedule C with your Form 1040, you are more likely to be audited than if your business is a partnership or corporation, in which case you file a separate tax return for the business.

The IRS calculates whether the expenses reported on sole proprietors’ returns are higher than those reported for similar businesses and in relation to your revenues. If your expenses are higher, the likelihood that you will be selected for an audit is increased.

Although recent legislation has curtailed some of the powers of the IRS, it is still up to you to prove that you have reported all your income and are entitled to the deductions you claim for expenses.

The tools at the disposal of the IRS auditor are impressive. They include the power to inspect your checks, bank statements, invoices and bills, and the journals, ledgers, and financial statements that record and summarize your transactions. The auditor can inspect your premises and can also require outsiders to provide records relating to their relationship with you.

There are two types of IRS audits: the office audit and the field audit. The office audit is conducted in the IRS offices and is generally used for smaller businesses. The field audit is used for larger businesses, is more intensive and takes longer. Where possible, you should avoid having the IRS come to your office.

The first thing the IRS auditor looks for (and also the worst thing that can be found) is unreported sales or receipts. This is particularly prevalent in businesses that have a lot of cash transactions, such as restaurants, cab drivers, bars, etc. If the auditor obtains convincing evidence that you have deliberately not reported all your sales or receipts, you could be found guilty of fraud and could even go to jail. The IRS shows little mercy to taxpayers who understate sales or receipts.

The next area of interest to the auditor is whether you deduct personal expenses as business expenses. Separating personal expenses from business expenses is sometimes complicated, especially in a smaller business. A favorite target of the IRS auditor is the claiming of personal auto expenses as business expenses and claiming personal entertainment, meals, and travel costs as business expenses.

The best way to avoid this is to fully document (through logs, etc.) any business use of a personal asset or personal use of a business asset.

Other areas of interest relate to employment/payroll issues: reporting employees as independent contractors and filing payroll tax returns and making payroll tax deposits. You can be personally liable if you fail to make payroll
tax deposits.

Audit notices are typically sent out about a year after you file your return; however, the IRS has three years after your return is filed (including extensions) to select you for an audit. If you fail to file a return, there is no time limit. Also, the IRS can extend the deadline if it suspects fraud.

David P. Yon is executive vice president and CFO for Associated Industries of Florida and affiliated companies.

Sept/Oct 1998 -- Florida Business Insight, PO Box 784, Tallahassee, Fla. 32302
(850)224-7173, insight@aif.com