A tax audit is a scary thing for any business to face. Even an experienced CFO or accountant can run into obstacles when selected for an audit by the IRS.
You must be able to prove all the numbers you report, and certain deductions are more likely to attract the ire of the IRS. Expense management solutions are needed to ensure that every cent is accurately accounted for.
Whether you own a business or work for someone else, taxes are inevitable. Be prepared for the government by proactively avoiding an audit and satisfying the requirements if it ever happens.
Tips to avoid an audit
Every tax return filed with the IRS is assigned a computerized discriminant index function (DIF) score. Higher scores are more likely to be selected for an IRS audit, and although the exact formula isn’t publically available, there are certain factors that are more likely to trigger an audit.
Another measure is when 1099 and W-2 forms are compared to returns to ensure income is properly reported. Unreported income and deductions greater than reported income are both possible red flags to trigger an audit.
U.S. tax law is complicated, but a company’s controller can produce the best possible DIF score by following four best practices.
- Be accurate
According to Intuit, the most common reason for an IRS audit is data entry error. The more manual your expense management process and other accounting functions are, the more likely you are to make errors.
These days, expense reports are often digitized, but a 2017 survey of 5,000 small to midsize business accounting controllers found that 18 percent of these businesses don’t use any accounting software at all.
Even when business expense tracking software and accounting platforms are used, Workday’s Future of Financial Reporting survey discovered that a shocking 69 percent of CFOs still rely on spreadsheets to build reports.
This means the first and most vital step to avoid a tax audit is to invest in an accounting, invoicing, and expense management software. With upgraded fintech, much of the reporting process can be automated, leaving little room for reporting errors.
- Save receipts
You don’t need to send copies of every receipt to the IRS with every tax return. However, if you’re audited, it’s likely that this information will be necessary. Saving receipts and documentation for up to a rolling seven-year period is a best practice, as the IRS will go back up to six years during the audit process.
Business deductions and expenses need to be substantiated, especially when it comes to T&E. Thankfully, smart receipt apps have the product functionality to fix this. They include Optical Character Recognition for mobile (or Automatic Character Recognition in webexpenses’ case), so it’s much easier to digitize, categorize, and store receipts, even when you are on the road.
Using this technology, a picture is taken of a receipt, and the information is uploaded to an expense report software as a starting point for building an expense report. Find the best expense software and mobile app for tracking expenses and receipts for your business, and get the team trained on how to use it. This way, if you’re audited, running the necessary reports is as easy as pressing a button.
- File and pay on time
A survey of 1000 small businesses from the National Small Business Association found that 64 percent of American small businesses spend at least $1000 annually on tax preparation alone.
According to the World Bank's Doing Business report, American companies spend an average of 175 hours on tax-related duties.
Waiting until the last minute is a sure shot way of bogging down your accounting department and rushing to file a late return riddled with errors. Needless to say, this will hoist the right number of red flags to get you audited.
On top of that, paying taxes late incurs fees from the IRS. Stay on the good side of the IRS by never being late for anything, for any reason.
- Watch your deductions
Honesty is always the best policy, especially when dealing with the IRS. Creative accounting to use corporate travel for personal use or other business expense management tricks can quickly go overboard and draw the attention of the IRS.
The agency compares your returns to other similar returns to check for statistical anomalies, and if you stick out, you will be hammered.
A common mistake is to classify full-time workers as independent contractors, something the IRS routinely looks for. Always review your return before submitting to ensure that business deductions are correctly calculated.
What to bring if you’re audited
Regardless of how careful you are, there’s always a random chance you’ll be selected for an audit.
In addition, if someone you do business with is audited, the IRS may audit you to assist in that process. So even if you follow all these rules, you may still be subject to an audit.
If you’re audited, here’s what you need to bring with you.
Equipment and vendor records
The odds of escaping an audit without owing money to the IRS are slim. But it’s also possible you missed the deductions that you qualified for the first time, so don’t be afraid to show records of every expenditure.
Keep in mind that third-party documentation, oral testimony, and other forms of verification can substantiate these expenses. Dig through bank account records and credit card statements; call vendors if necessary to gather records of every transaction.
Business expense management solutions typically track all this information, but if you didn’t have one in place the past seven years, you’re going to need to do some manual work to rebuild records.
If a vehicle is used for business-related travel, maintenance and other expenses can be reported. Estimating these costs is a dangerous game, and there are ways to determine (and prove) mileage traveled in the event of an audit.
GPS and mapping programs like Google Maps can prove you were on the road, and credit card receipts used for gas and repairs can make life easier. Business expense management software like Mint and wWebexpenses are helpful in categorizing these expenses too.
Travel and entertainment records
Corporate travel involves more than just vehicle mileage. You must also consider food, lodging, and other business expenses. Travel and expense management is one of the most manual processes in most businesses, but it doesn’t have to be that way.
Webexpenses offers expense reporting software with advanced OCR and product functionality for mobile allowing travel expense management on the spot. Providing much better performance than conventional OCR scanning, the smartphone app can convert a paper receipt into a digital claim in under 20 seconds. It’s the best app for tracking expenses and receipts on any platform and easily integrates with accounting software like QuickBooks.
Appointment logs and diaries
Of course, proving that expenses were paid is only one part of the puzzle. You’ll also need to prove it was done for a business purpose and not a hobby or other personal use. This is where appointment logs and digital calendars come handy.
By submitting a schedule of appointments, meetings, and other business events, you’ll provide a framework to prove to the IRS that you are paying for business expenses.
Although an IRS audit can be stressful, it’s doesn’t have to be. Take these steps now to ensure continued compliance. Even if you are audited, it’s much easier when you’re prepared.