Inside Small Business | Small Business & Home Business Marketing

5 Ways to Avoid Tax Problems with the IRS

Barbara Weltman
BarbaraWeltman.com

With the April 15^th filing deadline around the corner, as a small business owner you’ll want to take every precaution to “audit proof” your return and avoid hassles with the Internal Revenue Service. You want to take every deduction and credit you’re entitled to, but you also want to send in a return that’s likely to stay under the government’s audit radar. Here are five steps you can take to minimize inquiries into your tax return and prevail if any inquires do arise.

1. Pick up figures from information returns. Be sure to report exactly any income, expenses, and other items that have been reported to you (and to the IRS) on an information return. For example, if your business is run as an S corporation, then your share of business income and expenses reported on the corporation’s Schedule K-1 should be included on your personal return. The IRS has a copy of this Schedule K-1 and can compare it to the figures you report on your return. The same is true for W-2s, 1099s, and other information returns.

If you think that any of the figures reported on information returns you received is incorrect, first contact the issuer. For instance, if you’re an independent contractor who earned $1,200 from a particular company in 2008 but the Form 1099-MISC you received said you earned $12,000 from this company, contact the company so it can issue a corrected information return. If you can’t get a corrected form (e.g., the company is now out of business), then report the incorrect amount (the figure that’s been reported to the IRS) and then make an adjustment on your return; attach a statement to your return explaining the discrepancy.

2. Apply appropriate limitations. While most business-related expenses are deductible, there may be limitations on how much can be deducted and when. For example, if you take customers to lunch to discuss business, you can deduct the cost…but only up to 50% (the limitation in the tax law). Even though the expense is legitimate, you cannot deduct the full amount-now or at a later time.

If you purchase a vehicle costing more than about $15,000 that you use for business, the law only allows you to deduct a depreciation allowance up to a set dollar limit each year. Make sure you don’t write-off more than the allowable amount or you’ll invite IRS trouble. For example, if you purchased a new sedan in 2008 that you used 100% for business, the maximum depreciation allowance is $10,960; if the sedan was pre-owned, the dollar limit for depreciation for this car is only $2,960.

3. Supply all necessary information. Be sure to fill out all forms and schedules required to complete your return. For example, if you’re a sole proprietor, be sure to answer all of the questions in Part IV of Schedule C about your car or truck if you claim any write-offs for a vehicle.

Include any required attachments or statements explaining entries on your return. For instance, if you claim a bad debt deduction, you can’t simply deduct the loss; you must attach a statement to the return detailing the nature and extent of the bad debt.

4. Keep records and receipts. Despite your best efforts, your return may be selected for IRS examination (there are some random audits that you can’t prevent). In order to substantiate the positions you’ve taken on the return and avoid owing any additional taxes, be sure to keep appropriate records and receipts. For example, if you bought a customer a gift and deducted it, you’ll need to save the receipt for the gift, along with a description of the gift, the date it was given, and the person you gave it to, along with your business relationship to the person (e.g., the person is the head of purchasing at XYZ Corp.).

5. Retain proof of filing. While the IRS usually has only three years from the filing of a return in which to raise questions about that return, there is no time limit if a return has not been filed. It’s up to you to keep the proof that you filed a return so you’ll know when you’re out of the woods from audit exposure.

• If you file a paper return, retain a copy of the return, along with the receipt showing it was send by certified mail. If you sent it via an IRS-approved private carrier, such as FedEx or UPS, keep the company’s tracking slip showing when it was delivered.
• If you file your return electronically, retain a hard copy of the IRS electronic acknowledgment that the return was accepted for filing, along with a copy of the return.

Keep this proof forever!

* About Barbara
Barbara Weltman is a top selling author, attorney, tax and small business expert.  Barbara serves as an expert on Bank of America’s Small Business Online Community. She recently conducted an expert forum on the Small Business Online Community, where she answered questions about the impact of the stimulus package on small business owners. Barbara has also authored several books include “J.K. Lasser’s Small Business Taxes” and “The Complete Idiot’s Guide to Starting a Home-Based Business.”

Posted on Wednesday, April 1st, 2009 at 10:22 am and is filed under Business, Money/Finance. You can follow any responses to this entry through the RSS 2.0 feed.