What Auditors Look for When Examining a Business
Know what an IRS auditor looks for when examining your business and its records.
First and foremost, the IRS training manual tells its auditors that they are examining you, not just your tax return.
The auditor wants to see how you match up with the income reported on your return -- "economic reality" in IRS-speak. If your business is audited, the IRS is likely to investigate these issues:
- Does your lifestyle square with your reported income? An auditor sizes you up for dress style, jewelry, car, and furnishings in your home or office, if given a chance to make these observations. Someone who looks like a Vegas high roller, with the tax return of a missionary, will cause any auditor to dig deeper.
- Does your business handle a lot of cash? If your business handles a lot of cash, expect the auditor to suspect skimming, or diverting income into your own pocket without declaring it.
- Did you write off auto expenses for your only car? Personal use of your business-deducted set of wheels is so common that auditors expect to find it. That doesn't mean they will accept it, however. Auditors don't believe you use your one-and-only auto 100% for business and never to run to the grocery store or the dentist. If you operate your car for both business and pleasure and claim a high percentage of business usage, keep good records (preferably a mileage log).
- Did you claim personal entertainment, meals, or vacation costs as business expenses? Travel and entertainment business expenses are another area where the IRS knows it can strike gold. Document all travel and entertainment deductions. Taking buddies to the ball game and calling it business won't fly if you can't explain the business relationship in a credible fashion.
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