Last Call on Avoiding an Audit

Risk of a tax audit generally goes up when you operate in an environment where cash is king.  The connection between an all cash business and opportunity for tax evasion is pretty obvious.  Another factor that keeps the IRS focused on these types of businesses is the potential for record keeping snafus that make it likely they’ll be able to find a way to make it worth the auditor’s time to spend time with you.  Even if you are pretty diligent about record keeping, the rules do keep changing, making it more difficult to make your case that you’re being honest.

This year if you have a cash intensive business that also takes credit cards you have more recordkeeping  worries to keep track of when you get a form 1099 K from your payments processor.  This form will show all the funds that were sent you business based on credit card transactions.  The IRS will start from the position that this is all taxable income to you.  If it includes non taxable funds such as sales tax, you have to deduct that on your return.  If you give discounts or cash back that isn’t reflected in the credit card total – it’s up to you to do the reconciliation.  Once again good record keeping is the essential ingredient for success here.  

Another third party reporting item that can trigger additional IRS attention is cash transactions of $10,000 or more involving banks, casinos, car dealers and other businesses.  Recent IRS research indicates these large cash transactions tend to be associated with productive audit leads, so if you’ve had this type of transaction in the last year, make sure you’ve got everything buttoned up in terms of your record keeping.  Also make sure that you disclose money held in foreign bank accounts.  If this is the first year you are volunteering that information,  locate the documents verifying that you opened the account in tax year 2011. 

Speaking of double checking things, do take a second look at your return before you sign and send.  Math errors are the leading cause of IRS communication with taxpayers.  Even though miscalculations don’t necessarily lead to a full blown audit, when they’re in your favor, it does increase the risk the entire return will be pulled for an audit.

Once again, let me emphasize, it’s important and correct to take advantage of every opportunity for tax avoidance available to you.  The flip side of that equation is that is the more options you have to not pay taxes, the more you have to focus on maintaining records that show your deductions are legitimate.  You don’t have to hold on to this information forever.  The regular statute of limitations for revisiting a tax return is 3 years.  If you have an underpayment of 25% or more it jumps to 6 years.  If the IRS believes fraud is involved, there’s no limitation.