If you are planning to or just getting your entrepreneurial endeavor off the ground, you may feel as though an IRS Audit is not something to worry about just yet. While your chances of being audited may be relatively low, planning as if you will hear from the IRS could help you survive a challenge. Business owners of any size company get themselves into hot water by keeping sloppy records, last-minute transactions, blurring the lines between business and personal purchases or between separate corporate entities, and other complex business arrangements.
- Transactions between related parties require more, not less, documentation than those between unrelated parties. Draft a written lease, rental agreement, promissory note, bill of sale, employment contract, etc. Deals should be similar to what two unrelated parties would agree to in an arms’ length transaction. Go through the same formal motions as similar businesses.
- Documentation is critical. Record the date, cost, place of meal or entertainment, type of expenditure, names of persons entertained, business discussed, and business relationship. Keep a contemporaneous log or diary. Don’t try and go back and record expenses long after they are incurred.
- Do you have a board of directors or investors? Get them to approve deals.
- Meals and travel and entertainment expenses are always a magnet for attention. Therefore, be prepared for a challenge.
- Be particularly careful about trying to combine business and pleasure. For example, if you’re taking clients to a ball game on your husband’s birthday, use extra care. Don’t be surprised if the IRS or court asks if you had relatives at the business destination.
- You can’t deduct expenses for a spouse on a business trip unless he or she is employed by the business and there’s a bona fide business reason for his or her presence.
- Deductions for business gifts are limited. If you want to compensate workers with more than the $25 limit, you should generally pay the individuals or provide the gift and give them each a 1099 or W-2 (whichever is proper) for the value.
Fallbacks and Follow-throughs
- You may be able to use your own statement, written or oral, to support an element, but this should be a fallback position. The credibility is generally less than a contemporaneous written record.
- If you must testify about what is claimed on your tax return, make sure your testimony is knowledgeable and consistent. Get advice from your attorney before going to court.
- After you have an agreement with a related business, make sure you stick to it.
Guidance and Perspective
- Business owners often have a more liberal view of business expenses than the IRS. If the dollars involved are significant, talk with your tax adviser about the rules.
The best way to make sure that your intentions align with your actions is by keeping meticulous records and through knowledge of the IRS audit process from day one of your business. To get your business started the right way, consult with a Gordon Advisor on audit protection and download our Owner’s Guide to Profit Planning.