Everyone has at least one pet peeve. The IRS has many. Here are some items the tax agency may target on your company’s 2015 tax return – and ways to safeguard against an IRS audit.
Watch out for IRS hot button issues
A privately held C corporation may try to overpay its owners in lieu of paying dividends to avoid double taxation. Conversely, an S corporation that’s not subject to corporate-level taxes might try to underpay its owners to minimize payroll taxes and, instead, make higher distributions. The IRS is on the lookout for whichever ploy applies to your company and may compare your owners’ compensation to that of other firms in your area.
How much should an owner get paid? There’s no right answer for every company. It depends on what unrelated third parties with the same responsibilities, schooling and experience receive for performing the same functions. Outside sources, such as headhunters and various compensation surveys, can be used to substantiate your owners’ compensation expenses.
Meals and entertainment expenses
Excessive meals and entertainment expenditures are likely to catch the IRS’s attention. You generally can deduct up to 50% of business-related meals and entertainment expenses incurred for the purpose of entertaining a client, customer or employee. Maintaining detailed records is the key to protecting your meals and entertainment deductions.
Be sure that your company’s expense reimbursement forms require the amount, time and place, business purpose and name and business relationship of any person entertained. Hold onto these records until the statute of limitations runs out – usually three years from the due date or the filing date, whichever is later. However, keep in mind that the IRS can go back more than three years if it suspects a substantial omission of income or tax fraud.
Net operating losses
When expenses exceed revenues, a business may incur a net operating loss (NOL). Businesses may elect to carry back (or forward) NOLs to offset income in other years. The IRS may ask your company to substantiate the loss, not only in the year it’s incurred, but also when a refund is claimed for an earlier (or later) year. So, proper record retention is essential with NOLs. IRS instructions recommend saving records until NOLs no longer have an effect, plus seven years.
How to Manage an IRS Inquiry
A small percentage of tax returns are audited by the IRS. Sometimes a business is randomly selected. But in many cases, high-risk or excessive deductions trigger an audit.
The IRS wants to make up for a tax gap that’s estimated at more than $300 billion. So, it’s become more efficient and targeted in its audit efforts. The IRS keeps “norms” on how much businesses under each industrial classification code typically deduct for each line item — but, unfortunately, it doesn’t publish industry norms to the general public.
If you receive a notice from the IRS in the mail, contact your tax professional immediately. He or she can help you respond to the notice or question, which is often all the IRS needs to satisfy its inquiry. A tax professional can manage your ongoing correspondence with the tax agency. When an outside tax professional gets involved, it can limit your direct interaction with IRS agents. Consider having your tax advisor on site throughout the audit fieldwork. You can direct IRS questions through your tax advisor who can help steer to resolution and avoid wrong turns.
Beware that the IRS never initiates contact with taxpayers via telephone, social media or e-mail. If you receive an e-mail, text or phone call from the IRS, it may be fraudulent. Contact the IRS or Federal Trade Commission immediately.