The jokes about being audited by the IRS are endless. But if it happens to you, it’s no joke. Do you want to protect yourself?
First, understand why businesses may be audited. Businesses are selected for audit based on many factors. The following are examples of factors that may increase the likelihood of a business being selected for audit:
- DIF Score: When your tax return is filed, the IRS gives it a DIF (discriminant index function) score. The higher the score means the more likely it is the return will be chosen for an audit. The IRS doesn’t disclose the DIF mathematical formula but it is generally based on the frequency of high risk items contained on the returns filed.
- Referrals: Every business loves warm referrals – except this kind. When a related party is chosen for an audit, they aren’t the only ones who’ll come under the microscope. If you’ve been paid by a business that’s being audited, your business tax return could then come up for audit.
- Document Matching: The IRS matches the payer’s reported income to the 1099 or W-2 issued to the payee to make sure the payee has reported the income.
If you do find yourself under the microscope during an audit, the IRS will focus on many different factors and circumstances that reach beyond the figures reported on the tax return. The following items may also be evaluated during the audit process:
- Lifestyle. Auditors pay attention to much more than your forms. They size you up for how you dress, expensive jewelry you might be wearing, the car you drive and furnishings in your home or office. Appearances that don’t match up to your reported income could cause additional scrutiny..
- Cash Status. If your business is primarily conducted with cash, the auditor might request additional information and support to ensure that all cash receipts are accounted for and that there are no issues of underreporting.
- Car Use. Are you a one-car family that reports 100 percent business use for the car? The IRS can figure out that if you have only one car, you will be making the occasional trip to the grocery store, among other places. Thus, this may be an area that is opened up for additional scrutiny.
- Business vs. Hobby. Is your business truly a business, or is it a glorified hobby? The IRS agent will want to ensure that the activity is held open with the intent to be profitable and be operated as a business before allowing the expenses from the activity to cause a loss.
If you’ve never been audited, consider yourself lucky, but don’t assume that it could never happen. Be proactive in your business rather than reactive. And if you are facing an audit, “Keep Calm and Call Your Tax Professionals.” They can take the emotion out of it, and, just as important, they know the tax laws. They also know ways to assist with keeping you safe during the audit process. For instance, they might be able to unearth deductions that you could have missed. If that’s the case, it could possibly offset any discrepancies in your return that the IRS finds. Whether you will soon undergo an audit or want to be prepared for one, give us a call.
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