Will the IRS auditor be smarter than the person you hired to prepare your taxes? If you thought government workers weren’t worth their wages, it’s time to rethink, at least for IRS auditors. In 2007, the Internal Revenue Service (IRS) hired MBA graduates. In recent years they have received a lot of good field experience. Now, the same agents are being trained to use QuickBooks (the most widely used accounting software for small businesses).
Audit Rates From October 2008 to September 2010: C corporations with less than $10 million were audited 0.9% of the time; C corporations with more than $10 million were audited 14.5% of the time; S corporations and partnerships were audited 0.4% of the time; Individuals were audited 1% of the time; People with Schedule C businesses with revenues of $25,000 to $100,000 were audited 1.9% of the time; and Individuals with Schedule C businesses with $100,000 to $200,000 in revenue were audited 4.2% of the time (and a 3.2% audit rate for more than $200,000).
What did the IRS find in prior years? In 2003 and 2004 (the “good” years for the economy), the IRS found that 12% of S corporations in 2003 reported no income and this increased to 16% in 2004; S corporations with less than $200,000 in assets had a higher percentage of underreporting than large S corporations; This is likely due to better internal controls, bank covenants, financial reporting, and passive shareholder accountability.
The IRS is now starting a new audit cycle for tax years 2010 through 2012. The IRS is focusing on: Employment status, including can your employees work in the US? Employee vs. Independent Contractor: Do you have contractors that should be employees? If the IRS catches you, you will be responsible for Social Security and Medicare taxes; Reasonable Compensation (Are You Paying Yourself Enough?) If you are paying yourself $10,000, but another company would have to pay you $100,000, you would be deemed to pay Social Security and Medicare tax on the difference; S Corporation Distributions Vs. salary: IRS guidance shows that you should have 50% of the money you take out of your s corporation as salary and the other 50% can be distributions; Shareholder distributions must be voted on and declared by the corporate board of directors; and matching taxpayer identification numbers
You may feel this isn’t fair, but statistics show that small businesses were too “pushy” or didn’t follow the rules in the past. This can be a dangerous combination as the taxpayer signs the return there under penalty of perjury (and hiring a professional is no excuse). The dangerous combination is that tax professionals sell what most taxpayers want to hear, that you may deduct an item you perhaps shouldn’t; tax preparers who do not keep up with changes in the tax law; tax preparers who don’t always graduate from college; and IRS agent with an MBA and experience.
You may ask your tax preparer many questions each year: Do you really need my supporting documents? Do you really need to see my QuickBooks? Are you being too conservative? The answer is to take the time to make sure your tax work is being prepared correctly (the quality is high). This way, if you do get audited, you won’t have to worry about a big adjustment or perjury charges. A good tax preparer will read tax law updates and court cases and ask you the right questions to find the areas where we can play offense, but also the areas where we need to play defense. You don’t have to be a conservative, but you do need to know and understand tax rules and regulations and how they are applied.