Audits aren’t as problematic as you may think – according to the IRS, just a little over 1% of corporate returns from 2014 were audited last year, and the majority of those were conducted through the mail rather than in the field.
Still, it is always better to layer on the protection, and since taxes are probably on your mind anyway, now is a great time to take those extra steps to boost your chances of making it through an audit unscathed.
Recorded Minutes and Meetings
A lot of business owners assume that fastidious record-keeping is a corporate problem, and that sole proprietorships, partnerships, and LLCs are all exempt from recording their meetings and minutes. And while it is true that, in most states, only corporations are required to keep minutes from shareholder and executive meetings, all businesses should keep these types of records.
Audits normally begin by examining minutes and records of meetings, be they between the business’s owners or between the company and a potential client, and the last thing you want to do before an audit is scramble to update records supporting your expenses and deductions.
An Operating Agreement
Not every business distributes its income in the same way and, unless you run a sole proprietorship or a corporation, the IRS will want to see how your company distributes profit.
Sole proprietorships are assumed to pass profit directly to the owner, and the bylaws of most corporations outline the distribution of dividends, but other business entities can complicate profit and income allocation.
Partnerships and multi-member LLCs normally distribute profit based on how much each owner put into the business, but that is not always the case.
Further, if a business is unable to make profit consistently, the IRS may deem it a hobby and keep filers from claiming expenses, unless they can prove they are running it as a business.
It is a good idea, then, to have a document that states exactly how expenses and losses are allocated, and outlining how the business is run.
Formal Financial Statements
There is no law requiring that businesses, other than corporations, keep “formal” books – you can certainly hand over a shoebox full of receipts and let an auditor go to work. But you do not want to make the life of an IRS agent any harder than it already is since, if you are forcing them to guess what deductions are coming from where, they are not going to guess in your favor.
Worse yet, if you run a sole proprietorship or partnership, they may take this act as a sign you are not running a business at all. Keeping a set of up-to-date financial statements and records is just good practice to begin with, so make sure your books are up to date. That way, if an audit does come your way, the IRS will be out of your life before you know it.
Every business owner should have some sort of means to track activities, meetings, and expenses. It does not matter who you are or how great your memory is – you will forget specific details about the day-to-day operations of your business. Unfortunately, when being audited, those forgettable details matter a lot.
The IRS tends to meticulously comb through expenses related to travel and entertainment as, by law, you must have a written record of the business purpose undertaken. Business owners who are able to crack open their calendar and list exactly who they drove to meet, or what restaurant they took perspective clients to, on a particular day looks way better than those haplessly guessing and estimating their way through an expense report.
Most people and businesses never have to suffer through an audit, but sometimes it is just a pain you are forced to endure. The best tip for any business dealing with an audit is to just make the IRS’s job as easy as possible. Fighting them is not worth the trouble.
Instead, keep meticulous records of any money spent on the business – record any meetings, rentals, purchases, and profit – and be ready to hand them over. As long as you are confident and able to defend that list of expenses and deductions, the audit should be nothing more than a minor inconvenience.