Posted 3/7/01 Beware the small business audit According to the Minnesota Society of CPAs, knowing in advance what can trigger a small business audit and what auditors are likely to look for can help you conduct your business in a manner that minimizes audit risk. What triggers an audit? The exact triggers for an audit are difficult to pinpoint and vary from industry to industry and from year to year. For example, in the beauty salon and barber shop industry, where a fair amount of cash changes hands, the focus may be on unreported cash, while in the computer and technology industries, auditors are more likely to be looking for businesses that abuse the tax credit for research and experimentation. In recent years, businesses that claim the home office deduction and taxpayers who file Schedule Cs have come under increased scrutiny by the IRS. Here are several scenarios that may very well capture the attention of the Internal Revenue Service. ïUnreasonable compensation ó IRS auditors are looking carefully at what the IRS considers ìunreasonable compensationî for officers of family-held corporations. If the IRS decides that an officerís salary is unreasonably large, it may disallow the companyís expense deduction for the excess and treat it as a nondeductible dividend distribution. To protect themselves, owners should keep records of hours worked, educational background, any unique talents or contributions the owner provides to the business, and the number of jobs performed that might normally be carried out by several people. ïUnusually high business-related deductions ñ The key here is to maximize your business deductions without overdoing and attracting attention to your company. For example, excessively high deductions relative to your business income are likely to raise a flag with the IRS. Your best defense is thorough documentation of every deduction. ïPersonal entertainment, meals, or vacation costs disguised as business expenses ñ Travel and entertainment expenses are another area where the IRS goes in expecting to strike gold. Be sure that you are well-versed in the rules for combining business and pleasure and that you have all the records required to support your T&E expenses. ïEmployees misclassified as ìindependent contractorsî ñ The rules governing independent contractors are complicated. If you rely on independent contractors in your business, be sure you read IRS Publication 1976 which outlines the rules or consult a CPA for some assistance. What the auditors learn Todayís auditors are likely to be more informed as a result of the IRSís Market Segment Specialization Program (MSSP), a program designed to develop highly-trained examiners for particular market segments. As part of this program, the IRS is creating Audit Technique Guides (ATGs), special publications that provide auditors with industry-specific expertise and knowledge. These documents are very detailed. For example, the ATG for mobile espresso carts supplies auditors with a glossary of espresso terms, historical background on the growth of the industry, sample questions to ask the espresso cart vendor, and the types of abuses that are common to this type of business. Among the more than 50 ATGs currently available are guides for the laundromat industry, grain farmers, ministers, and for those in commercial banking. Most guides can be accessed online at www.irs.ustreas.gov or purchased by mail by calling the U.S. Government Printing Office at 202-512-1800. ©Post Review