Solid Strategies to Avoid Audits;
Many Americans are breathing a sigh of relief now that April 15 — “Tax Day” — is in the rearview mirror. For others, though, the fear of being hit by an audit is providing cause for anxiety.
It’s important to be mindful that tax strategies are critical for electronic security professionals throughout the year. With that caveat in mind, and for those of you who have recently filed extensions, there are practical measures to employ in order to avoid the wrath of Uncle Sam.
Today, under pressure from lawmakers to cut the tax gap — the difference between the amount owed by taxpayers and the amount actually paid — it appears that the risk of an IRS audit is noticeably increasing.
In fact, the IRS’ tax cheat dragnet brought in a record $47 billion during the 2006 fiscal year. Audits of individuals rose by 7 percent last year, while small business audits have more than doubled since 2000. The complexity of our tax laws and the confusion most alarm installers, dealers and integrators face trying to keep abreast of those ever-changing rules have all contributed to the increased success of the IRS’ auditors.
Avoiding Audits Is Not Hard to Do
Who wouldn’t like to ensure their tax returns — or those of their security business — escape examination by the IRS? A few security professionals have discovered sure-fire methods to ensure their return is selected: take big-time losses, operate as a cash business and keep sloppy records. Fortunately, avoiding audits is both legal and easily accomplished.
There is no justification for sacrificing valid deductions, even if large or unusual. Obviously, all income and deductions should be reported truthfully. If that means a higher chance of audit, so be it. But remember, in this electronic age, most transactions are reflected on the tax returns of your customers and suppliers.
An excellent strategy for avoiding an audit involves pointing out “oddball” items on the tax return. Give the IRS the answer before it asks the question. Attach a note, a brief statement, documents and explanations for all unusual transactions.
For large transactions that may fall into one of the innumerable “gray areas” of our tax laws, there is yet another tax form. Form 8275, “Disclosure Statement,” may help avoid penalties by disclosing questionable deductions, positions or investments. Few experts believe using this form will increase the chance of an audit.
When Offense Is Not Enough
What happens if, despite your best efforts, the IRS requests your presence to review your tax returns? It goes without saying the worst thing that any business owner can do if they receive an audit notice is to ignore it. The best bet is a quick response. It also helps if the business owner works with the IRS to resolve the matter.
If a small electronic security business has kept organized records, including bills, receipts and canceled checks, and has in place the proper internal controls, there is little need to worry. The IRS may interpret the operation’s situation differently, but there is no crime in having differences of opinion.
Thanks to the IRS Restructuring and Reform Act of 1998, small businesses now have many new protections in the audit process. First, the IRS’ ability to conduce so-called “lifestyle” or “economic reality” audits has diminished.
Today, the IRS is generally prohibited from asking for extensive information about a taxpayer’s financial status, standard of living and other information to determine the existence of unreported income. The IRS can only ask for that information if it has a reasonable indication that there is a likelihood of unreported income based on the tax return and information reports from third parties.
The IRS Is Watching for Red Flags
Many experts agree that an improperly prepared tax return is a good way to ensure an IRS audit. Sloppy returns are also hazardous.
Those electronic security business owners who fail to report all income send up an instant red flag in our computerized business world. Information mismatches produced by an erroneous Form 1099 received by some security professionals often creates disparities in reported income. If the amount reported on the Form 1099 is wrong, the individual or firm that sent the form should correct it and file an amended Form 1099. Intentionally mismatching the information of the tax return can only draw attention.
The biggest problem for most electronic security businesses — as well as their owners — is a lack of good expense records. The use of an automobile for business purposes is a classic example. Although the vehicle may have been used 75 percent of the time to call on customers, many electronic security professionals fail to keep a detailed record and, thus, are unable to state that clearly on a tax return. Records can be easily kept in the form of a log.
Those professionals who use an office in the home to conduct business, keep records or perform management chores may discover the risk of an audit is not worth the small tax deduction. The home office tax form (Form 8829, Expenses for the Business Use of Your Home) has for some time, been a definite audit flag.
If the owner of an alarm installation or integration business has only a minimal amount of deductible home-office expenses and poor records, the risk of an audit may not be worthwhile.
Also, keep in mind that the use of an office in the home can substantially reduce or even eliminate the unique home-office exclusion. That exclusion allows up to $250,000 ($500,000 on a jointly filed return) of gain from the sale of a residence to be excluded or ignored. An electronic security business owner cannot claim the exclusion for gains that result on any portion of that residence that is not used as a “personal residence.”
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