The idea of a tax audit instills fear in even the most scrupulously honest taxpayer. And with reason. Although the chances of being audited are relatively slim, "It can unnerve you and your employees," says Roy M. Quick Jr., the owner with his wife, Edith, of Quick Tax & Accounting Services, based in St. Louis, MO. "If the tax examiner is on site, it can have an effect on your customers, too," Quick adds.
Fewer than two million of the more than 100 million tax returns the Internal Revenue Service receives each year get serious review. Nevertheless, according to published reports, the IRS is specifically targeting small business returns, and the more money a company makes, the greater its chances of an audit.
Audits can be costly and time consuming for a small business, points out Marcy David, tax counsel for the National Federation of Small Business. Both she and Quick offer suggestions about what you should and should not do in your efforts to avoid an audit.
Above all, be prepared, Quick advises. The best defense is to plan for an audit while preparing your return. Here are these experts' tips:
1) Keep records and receipts. Original receipts, tax records and corresponding documentation should be kept organized and easily accessible for at least seven years. The IRS has up to three years to audit a return and up to six years to go after a filer if examiners think income has been underestimated by at least 25 percent. Davis suggests attaching original receipts, checks or insurance reports for large deductions to your tax return. "If your return is tagged for additional scrutiny, having the documentation attached could eliminate the need for a larger audit," she reasons.
2) File electronically. "When you file electronically, your return goes directly into the system without any eyes looking at it," Quick says, "which means there's no potential for screening by lower level clerks." In addition, "the IRS can't lose any part of your return when it's filed electronically," he adds.
3) File when the time is right. It's a myth that getting an extension increases your chance of being audited. Experts say it's more important to get the return right than meeting the deadline. Have the return prepared early, and if you have a refund due, by all means file early and get your money back. If you owe taxes, don't file early. Taxes paid prior to April 17 this year for 2006 are the equivalent of giving the IRS an interest free loan.
4) Don't hand write your return. "Math errors on returns that have been handwritten are common," Quick says. "So the IRS will look for those, and then they'll look for other errors."
5) Watch the home office deduction. The deduction for use of a home office is a red flag to the IRS. But just because the IRS tends to scrutinize this deduction, don't avoid using it when it applies, Quick advises. His company had a client that legitimately has a home office, but was too afraid to take the deduction. "We amended three years of returns and got him more than $5,000 back," he says. Your tax accountant can help you determine whether or not you are eligible for this deduction.
Information in this article was edited from a story in MYBusiness magazine.
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