By Manny DaRosa
Snow and ice management professionals are no strangers to being audited. As an owner, an audit can be the most stressful event in the business and could lead to the company folding if the results are not positive. While recent reports have said audits are becoming rare due to budget cuts, firms must be prepared for an increase in audit activity in the near future.
Firms with disorganized records or who are regularly late in tax compliance are prime targets for audits. When your tax advisor is preparing the taxes and your records are disorganized, revenue may be understated and expenses overstated. The IRS and state organizations use secret algorithms that can pinpoint records that are inaccurate. If you have bookkeeping records and are compliant with all company and payroll taxes, an audit can go very smoothly.
IRS focus points
Cash analysis. The overall tax audit normally starts with a long question and answer session to determine how many cash transactions are involved in the business. The most important tool being utilized more frequently is what the IRS calls a cash analysis, which is a reconciliation of all income and expenses reported on a taxpayer’s personal and business tax returns. Business and personal tax records and filings, including all bank statements, are fair game.
Subcontractors. Another area that is reviewed - and is a frequent target for service-related businesses - is the use of subcontractors. Many states do not recognize the use of subcontractors unless they are a legitimate LLC or corporation. You should require all subcontractors to provide corporation validation, liability insurance, and a business tax identification number.
Record retention. With regard to books and record keeping, the general rule has been that they should be kept for seven years and then disposed. In my opinion, all records should be stored for the life of the business if space permits. If they can’t be stored, records for normal operating income and expenses can be tossed but records that pertain to shareholder loan and shareholder draws, assets purchases and sales, and loan transactions should be kept permanently.
In the event of an audit, the following accounts will be tested at a minimum:
Revenues. The auditor will look for evidence that all sales are properly recorded and match to your sales records. It is vital to keep records of all sales orders and invoices.
Employee compensation. Wages must trace and reconcile to all payroll records filed by you or a payroll company.
Professional fees. The auditor will look to determine if expenses were in fact paid to a professional and not to a member of your staff.
Travel. Auto expense logs must be maintained to document all legitimate expenses. This is one of the most abused deductions, and without such evidence an auditor may disallow the entire deduction.
Office expenses. All receipts, canceled checks and credit card statements should be kept to substantiate office expenses. Auditors will look for large furniture and fixtures that were improperly expensed and should have been capitalized and depreciated over several years.
Miscellaneous expenses. Never use this account. Categorize every expense.
Legal documents. Auditors are frequently asking for the legal documents when the business was established and also ask for yearly annual minutes of meetings if you are incorporated. An incorporated company should always prepare minutes, especially when there are shareholder loans or capital purchases, and even change of owner’s payroll.
What to do and what to avoid
The most important thing you can do is come prepared and organized in category and chronology. Only volunteer what is asked for since providing too much information could result in additional work and questions asked by the auditor. You want to move quickly through the process with as little pain to you and minimal amount of inquiry by the auditor.
These are just a few tips to prepare for and survive an audit. I cannot stress enough the importance of good record-keeping, professional bookkeeping and a strong team of professionals (attorney, accountant, etc.) to help you navigate the process.
- Keep your records and receipts organized.
- Hire only legitimate subcontractors. Keep detailed records on how you use them.
- If possible, keep all records forever.
- During an audit, never volunteer any information beyond what is requested.
Manuel DaRosa is a CPA in Massachusetts. His firm caters to landscape professionals
and other service industries. Email him at Mdarosa@darosatax.com.