IRS overhaul may mean more audits
By Joyce M. Rosenberg
Associated Press
NEW YORK — A restructuring announced recently by the Internal Revenue Service could mean that more small businesses might expect audits of their tax returns.
The IRS said that in 2005, it will be adding 2,200 positions to its enforcement operations — its audit staff — having consolidated or cut back in other divisions. The agency noted that between 1996 and 2002, its enforcement staff was reduced by more than a quarter.
Accountants said they expect more audits of small companies and their owners. And although the staff won't be augmented until next year, agents can still look back.
"The feeling out there is that they have lost money over the years and they're trying to regroup," said Theodore Kravitz, a certified public accountant with ERE LLPP, an accounting firm based in New York.
Small businesses hoping to avoid audits should start by not putting anything into a return that could raise red flags — something out of the ordinary or something unexplained or excessive. The excesses tend to come in deductions for entertainment, home offices and cars.
What is excessive? That depends on factors such as what kind of business you're in, what kind of expenses you've taken in past years and the amount of your revenue.
Frank Lamanna, a CPA with Ison & Decosimo, an accounting firm in Memphis, Tenn., said problems tend to crop up with use of a car because many small-business owners use a vehicle for both work and personal activities. Some try to take too big a deduction based on use of the car for business.
Another red flag comes when someone tries to take a home office deduction for part of a bedroom that's used for a PC and fax machine. It's not that you can't deduct expenses for a home office, but it has to clearly be an office.
Perhaps a good rule of thumb is to use common sense in deciding what to deduct and not try to get away with something. It's wise to get the advice of a tax professional.
Another red flag comes from not listing income from a Form 1099 on a Schedule C. Many independent contractors receive 1099s from the people or businesses they work for, and Kravitz said the IRS is making a priority of matching the copies of 1099s it receives with the income reported on returns.
Business owners who file a Schedule C should also be careful about their personal returns. Raising questions from the IRS on, for example, Schedule A or B, can lead agents to start looking into the business part of your return.
Corporations have their own particular red flags. For example, Kravitz said, the IRS is on the lookout for shareholders/employees of what are called S corporations who might take excessively large dividend payments that in reality should be taken as salary. An excessive dividend payment enables a business to avoid paying payroll taxes — but the IRS will call it salary.
