Audit advice

guest commentary by David Potts

This may come as a surprise to certain small business owners, but the Internal Revenue Code requires you to keep records. And unless you are involved in criminal activities, it is to your advantage to keep records.

For those of you involved in criminal activities you need to get advice from an attorney, not an accountant. And just a reminder, purposely not reporting your income on your tax return is a criminal activity.

Regulations state, “any person required to file a return of information with respect to income, shall keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information.”

If you own a small business, you should be aware that the IRS is targeting small businesses such as yours for examination of their income tax returns. For several years now they have been talking about reducing the “tax gap,” the difference between what taxes are paid by businesses and what the IRS believes is legally due. Now they are putting their money where their mouth is. A greater number of small businesses are having their income tax returns examined. So what should you do if your business ends up in the bull’s eye?

If you’re guilty of evading income taxes (a crime), hire an attorney. If you are guilty of avoiding income taxes (not a crime, but a right), here are a few things to consider.

First, you will feel your privacy has been invaded. That is normal. Your privacy has been invaded. However, the IRS does have legal authority to inspect your records. The regulations state, “The books or records required … shall be kept at all times available for inspection by authorized internal revenue officers or employees, and shall be retained so long as the contents thereof may become material in the administration of any internal revenue law.”

The IRS auditor, a revenue agent, will at times be able to see very personal information. Did you really spend more at the liquor store than you contributed to your church? Did you really think you could deduct the cost for that online dating site? Be careful what you document and how. Remember you may not be the only person to see your books and records.

Your revenue agent isn’t stupid. Don’t you be. Hire a CPA to represent you. A good CPA knows more about income taxes than you do and he or she won’t go on and on saying more than should be said after the IRS asks a question about your business. During the last 25 years, I have had an occasion or two where a client has wanted to participate in the audit of their return. Big mistake. Many people under examination, when asked a question by a revenue agent, tend to give too many unnecessary details when answering the question. Details that aren’t actually related to the question asked. Details that inadvertently identify other issues that may now be examined. Costly details.

You should realize that before the IRS contacts you, they already know a lot about you. You know and expect the IRS has certain information that has been reported to them on W2’s and 1099’s. You might not be aware the revenue agent has reviewed other public records. He knows where you live and how much you house is worth.  He knows what cars you own. He has probably googled your name. He will have a basic understanding of your lifestyle and if your lifestyle exceeds your income, you may have issues to discuss with him.

The IRS is using technology to its benefit. The IRS is now asking for you to provide your records in electronic format. Instead of asking for you to print reports from Quickbooks, the revenue agent may now ask you for your Quickbooks data file. The IRS has or is training 1,100 revenue agents on Quickbooks Premier Accountant Edition 2010 software. Be careful! Don’t step into that dog pile. If your 2009 income tax return is being audited and the revenue agent asks you to provide your business’ 2009 Quickbooks file, what are you actually giving him? How long have you been using Quickbooks? Unless you have eliminated the transactions before and after the 2009 tax year from your Quickbooks file, you are giving the IRS information for all the years you have kept your books on Quickbooks. Is that five years of transactions? Ten? You may be inadvertently giving the revenue agent more information than is related to the year or years under examination. Your revenue agent isn’t going stop you from “voluntarily” giving him additional information.

At times it feels that Congress has declared war on small businesses. Although they quickly spout off that they support small businesses, the laws they pass are expensive and oppressive for small businesses. And with all the information reporting requirements it feels reminiscent of the cold war; like we are living in the Soviet Union, not the United States of America.

Congress no longer believes privacy is your right. And the depressing thought is that although we gripe about these laws we accept them. For example, don’t you still travel by air even though you have to drop you pants for the TSA before you board an airplane? This feeling of conflict and oppression will become more intense in the coming years as small businesses are required by recently passed laws to comply with even more expensive and burdensome information reporting requirements.

It is proper and prudent to arrange your business affairs to avoid paying income taxes. All small businesses should make time for tax planning with the intent of reducing their income taxes. Just keep in mind it’s criminal to evade income tax. The IRS may be the 800-pound gorilla in the room, but Congress writes these laws and the President signs the law.

So what should we do? Take the fight to Congress. Although I believe politics is dirty business, I believe it’s time for all small businesses owners to become politically active and demand intelligence in our tax laws. Just don’t wallow in the trough yourself and don’t forget to take a bath.

About Potts
David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas. You can follow more of his thoughts at ThePottsReport.com. Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case.

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