Small Business: Lessons Learned from an IRS Audit

Several years ago I received the dreaded letter—one “inviting” me to bring all of my paperwork to the local IRS office for an audit. After reading the letter, I couldn’t help but to flash back on getting summoned to the principal’s office as a kid. Though I hadn’t done anything wrong, I felt that unmistakable sense of trouble ahead.

I immediately called my tax planner, and she assured me it would be fine. She said that the IRS was stepping up their efforts to audit small businesses, but because we kept meticulous records and followed the rules, I had nothing to worry about. Sure, easy for her to say!

We showed up to the appointment several weeks later and finally got called back into the auditor’s office, which was essentially a tiny cubicle with a door. First up on the agenda was what the auditor called “an excessive amount of charitable donations.” At the time, I owned my first business—a new and used bookstore—and we donated hundreds of books to various charities each month. It never occurred to me that this could actually get me into hot water. We had claimed an amount within the guidelines (which was substantially less than what was actually donated), but apparently it raised a flag with the IRS. Once we explained, the concern was quickly dismissed.

Next, the auditor decided to spot check business expenses claimed over various years. She would ask for an explanation for a transaction on January 12, 2005, and my tax planner would have to pull up the information to explain each expense. Fortunately, we had kept copies of all of my credit card statements, receipts, and bank statements neatly organized in binders, so it was easy to flip through and find exactly what was requested.

I later learned that the IRS routinely does these spot checks to look for improper expenses. For example, if you had a business trip and booked two flights instead of one, you would need to prove that you took an employee—not a spouse or kid, otherwise it wouldn’t count as a business expense. And if an auditor were to stumble across a transaction like this, it would cause the whole process to accelerate into a more detailed audit, where nearly every line item in your financials can be called into question.

Fortunately, my books are very clean and I was dismissed from the audit after a couple of hours with no adjustments to previous years’ returns.

Lessons Learned from the IRS Audit

Keep Everything – You will be asked to show receipts, credit card statements, and bank statements. Keep all of this information organized so that you don’t hyperventilate if you receive a letter because they will want you to bring it ALL with you—and will likely request several years’ worth of records.

Hire Help – I’m always amazed when a business owner tells me he handles his own bookkeeping. First of all, it takes time away from things you could be doing to generate revenues! But you also can’t possibly know all the current tax laws. I strongly recommend hiring a bookkeeper who is a certified tax planner, or an accounting firm. It’s a small price to pay to have your books done right, and then you will have an advocate to come with you if you are ever summoned for an audit.

Get Legitimate Donation Receipts – Whether you donate cash or items to various charities, be sure to get a qualified receipt for your donation. I was told to make sure that a charity such as Goodwill writes down the exact quantity of any items donated (example: 5 bags of clothes, 3 boxes of books, etc.).

Separate Your Business Expenses – Never combine your business and personal expenses. For example, if you shop at Costco, ask the cashier to ring up two different transactions for your personal and business purchases, and then pay for them with two different accounts so these expenses aren’t inter-mingled.

Just Don’t Do It – It may be tempting to invite a friend or family member to travel with you or have a meal with you, but be sure to separate the extra expense as a personal one—not business. If the IRS sees even one minor indiscretion in this kind of expense, you could end up in a major audit that goes line-by-line for several previous years.

Overall, my audit experience wasn’t nearly as awful as I thought it would be. The auditor was professional, yet friendly enough to make it less intimidating (though I suspect they are trained to be nice so you’ll start talking!). As business owners, we can’t avoid getting called in for an audit as many are conducted randomly, but we can certainly be prepared and make sure we don’t have anything to worry about when we get there.

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I am blogging on behalf of Visa Business and received compensation for my time from Visa for sharing my views in this post, but the views expressed here are solely mine, not Visa’s. Visit http://facebook.com/visasmallbiz to take a look at the reinvented Facebook Page: Well Sourced by Visa Business. The Page serves as a space where small business owners can access educational resources, read success stories from other business owners, engage with peers, and find tips to help businesses run more efficiently. Every month, the Page will introduce a new theme that will focus on a topic important to a small business owner’s success. For additional tips and advice, and information about Visa’s small business solutions, follow @VisaSmallBiz and visit http://visa.com/business.

Stephanie Chandler is the author of LEAP! 101 Ways to Grow Your Business.
She is also CEO of http://AuthorityPublishing.com, a custom publisher of
nonfiction books, and http://BusinessInfoGuide.com, a directory of resources
for entrepreneurs. Also visit http://StephanieChandler.com